Can't Keep A Good Muni Down

Compelling Muni market technicals coupled with swift and direct policy intervention from both Congress and the Fed have created a strong tone that appears to have made the March onslaught a distant memory. Following a fairly quiet June with yields holding to a tight trading range and performance decidedly positive, July was even stronger with double the returns. Tax-exempts continue to exhibit relative cheapness compared to UST and corporates. The available cash theme continues with 12 consecutive weekly inflows into municipal bond mutual funds now a testimony to outsized demand for tax-efficiency and quality portfolio diversification. Net fund flows have now turned positive since the mass exodus in March. Market participants seem to be betting on the resiliency of muni credit as revenue displacement continues across virtually all sectors of the asset class. There is also the expectation that Congress will advance another fiscal relief package that will ultimately secure funding for state and local governments, colleges and universities, airports and K-12 education.

The revenue dislocation has forced many states to revise their budgets with new assumptions, the problem being that the assumptions are ever-changing. Much of the future revenue performance will be determined by consumer sentiment and participation and we are not expecting the economy to return to pre-COVID levels until at least 2022. For now, we think that an appropriate funding allocation for state and local governments should at a minimum be $500 billion, with a number closer to $1 trillion not unreasonable. In our view, the timing of further aid is critical to prevent additional furloughs and layoffs and even permanent job losses. Furthermore, budgetary constraints are forcing states to make very serious funding choices, and in certain states scheduled pension payments are being suspended in order to maintain essential services.

We would note that a preponderance of the negative headlines seem to envelop state and local G.O. credits, thus tending to enhance the demand for revenue bonds. Having said this, it is interesting to point out that recent default activity has largely involved some of the riskier revenue bond structures. One of our recurring themes, even before COVID-19, has been the outsized availability of cash ready for deployment, and the current trend of positive mutual fund flows strengthens this observation even though credit pressure remains front and center to the investment calculus. Strong investor demand continues to absorb rising new-issuance as net negative supply maintains its technical hold.

For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Professional.