As students around the country return to the classroom, it
strikes me that now may be a good time to get back to the
fundamentals on the municipal bond market as well.
The summer was a fairly tortuous one for the asset class, with
the S&P Municipal Bond Index having lost 5.57% between June
and August. In fact, most fixed income sectors struggled as
interest rates spiked after the Federal Reserve's first hints of
easing off quantitative easing
. Notably, the volatility in the muni market over the past few
months has had a lot to do with rates - and very little to do
with credit events (even big ones like
Despite the volatility and headline noise, in my opinion, the
reality is that the fundamentals underlying the municipal market
are stronger than they have been in five years. A big statement?
You bet. And here are just a few reasons to believe it:
State revenues have seen one direction - up.
States have notched 13 consecutive quarters of rising tax
collections, according to data from the Rockefeller Institute.
Preliminary data for April and May indicates that a 14
quarter of improvement appears to be in the making. While
revenues have increased, expenditures generally have been well
contained as states continue to function with a
level of fiscal discipline
that had been passé prior to the 2008 financial crisis. The
Institute notes that state and local governments trimmed more
than 680,000 jobs since August 2008, and are likely to continue
"doing more with less." Higher revenues and lower expenditures is
a fiscally powerful combination that has been leading to balanced
budgets and increasing reserves nationwide.
Moody's upgrades its outlook for states
Moody's recently revised its outlook on US states to "stable"
after five years at "negative." In addition to citing improving
revenues and reserves, the agency also noted in its announcement
that credit quality among US states remains "extremely high,"
with 30 of the 50 states having the two highest possible ratings.
In fact, as I noted in my post
"Three Pictures Paint the Big Picture in Muniland,"
the municipal market overall is relatively high quality, with an
average rating of AA as of year-end 2012.
Stronger housing = stronger locals.
While the recovery across local governments trails that of states
(Moody's maintains its negative outlook for locals), we would
point to strengthening housing prices as a promising omen for
locals. Property taxes make up the lion's share of local revenues
and, as such, strength in housing bodes well for local
governments. The National Association of Home Builders' First
American Improving Market Index found that
291 metropolitan areas
across the country qualified as improving housing markets in
September, a gain of 44 markets from one month prior.
Pension reform is gaining traction.
It's no secret that oversized pension burdens have been a drain
on state and local governments. Even with improving stock
markets, pension funded levels have languished. Ironically, the
financial crisis brought the pension problem to the fore, and the
hard work of addressing the issue has already begun. Between 2009
and 2011, 43 states enacted some sort of pension reform,
according to the National Conference of State Legislatures.
Detroit's large pension burden added an exclamation point to the
conversations, and may be the impetus for increased reform - and
relief for overburdened municipalities. We cite the California
city of San Bernardino as another potential precedent setter in
September market update
, with some expecting an eventual Supreme Court decision before
all is said and done. Ultimately, there seems to be a growing
acknowledgement that achieving greater local budget flexibility
will require a more aggressive approach to pension reform.
We are not Polyannas. We know the recent market correction has
been painful for muni bond holders. The ugly truth, however, is
that corrections are necessary. They restore value in the market
and present the opportunity for investors to buy in at attractive
levels - a new base from which your investment can grow. I think
that is exactly what the market is doing here - recreating value
from a point of very low,
, interest rates.
As illustrated in the chart below, over time, negative periods
in the municipal market have been followed by boons. For those
who are able to weather the near-term uncertainty, we think this
may be a good time to capture muni exposure at levels not seen
since 2011. The fundamentals in the overall municipal bond market
are strong, and we believe the market will acknowledge that fact
- and patient investors will be rewarded.
Bonds and bond funds will decrease in value as interest rates
rise and are subject to credit risk, which refers to the
possibility that the debt issuers may not be able to make
principal and interest payments or may have their debt downgraded
by ratings agencies. A portion of a municipal bond fund's income
may be subject to federal or state income taxes or the
alternative minimum tax. Capital gains, if any, are subject to
capital gains tax.
Peter Hayes, Managing Director, is head of BlackRock's
Municipal Bonds Group, and a regular contributor to
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