This Municipal Bond sector report is excerpted from Guggenheim Investments’ First Quarter 2019 Fixed-Income Outlook
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.
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.
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
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This material contains opinions of the author or speaker, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC.
Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy or, nor liability for, decisions based on such information.
Investing involves risk, including the possible loss of principal. Investments in bonds and other fixed-income instruments are subject to the possibility that interest rates could rise, causing their value to decline. Municipal bonds may be subject to credit, interest, prepayment, liquidity, and valuation risks. In addition, municipal securities can be affected by unfavorable legislative or political developments and adverse changes in the economic and fiscal conditions of state and municipal issuers or the federal government in case it provides financial support to such issuers.
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