Municipal Bonds: Weather Ready
Municipal bonds weathered fourth quarter volatility better than other fixed-income sectors, but careful selection remains key.
The municipal market reasserted itself as a safe haven in the fourth quarter of 2018 amid elevated volatility driven by a wide spectrum of concerns. Municipal bonds have been characterized as low-volatility securities as credit spreads hovered near the trough of post-financial crisis levels. Unlike Treasurys, municipals did not experience a bear flattening in 2018 and compensated investors who assumed duration risk.
Muni Spreads Tighten to Post-Crisis Lows Despite Broad-Based Volatility
Municipal bonds have been characterized as low-volatility securities as credit spreads hovered near the trough of post-financial crisis levels. Unlike Treasurys, municipals did not experience a bear flattening in 2018 and compensated investors who assumed duration risk.
Source: Guggenheim Investments, Bloomberg, Municipal Market Data (MMD). Data as of 1.25.2019.
Heading into 2019, implications of the Tax Cuts and Jobs Act and midterm elections help anchor expectations of relative outperformance. In response to lower corporate tax rates, institutional investors executed tax-motivated selling in 2018. Offsetting this reduced demand going forward, the inaugural limit on state and local tax deductions is expected to attract demand from disproportionately impacted states such as California and New York. Meanwhile, the midterm elections produced a divided Congress whose political gridlock will keep federal infrastructure programs (i.e., new supply) on the sidelines and maintain expanded Medicaid funding.
SALT Deduction Limits Stem Tax-Motivated Selling in High-Tax States
The inaugural limit on state and local tax deductions is expected to attract demand from disproportionately impacted states such as California and New York.
Source: Guggenheim Investments, Internal Revenue Service. Data as of 12.31.2016. Note: *Tax filers with adjusted gross income greater than $500,000.
With cautious optimism ahead of the next downturn, we stress the need for diligence to combat the natural information lag of issuers. Municipalities are often afforded a nine-month delay to report financials and an additional year for pension figures. As a result, market performance based on reporting of tax collections and pension health may fail to reflect economic conditions in a timely manner.
While maintaining a defensive position to weather the next recession, we anticipate that idiosyncratic opportunities will emerge as credit spread volatility increases with the reintroduction of Puerto Rico bonds to the indexes. As ensuing political pressure mounts on state and local governments to make hard choices to favor either bondholders, pensioners, or taxpayers, we place a premium on budget flexibility and robust structural protections.
—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director; Michael Park, Vice President
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
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*Assets under management is as of 3.31.2019 and includes leverage of $11.3bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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