Municipal Market Update
- March 17, 2020
Portfolio manager Kathy Krieg discusses the recent dislocations in the bond market and their implications for investors.
The municipal bond market experienced a massive dislocation this week. In fact, all fixed-income asset classes including Treasuries felt the pain with interest rates moving sharply higher. Interest rates on 10- year AAA and AA MMD scale jumped 0.80% to 1.68% from 0.79%. Massive bid lists from ETFs and mutual funds flooded the market, with fewer market participants willing to bid for bonds. As with all fixed-income investments, the bid-offer spread widened significantly to almost 30 to 40 basis points in some instances.
Investment-grade bond investors fared much better than high-yield investors with the Bloomberg Five-Year Muni Index posting a year-to-date return (as of 3/12/20) of -0.86% while High Yield Municipal Index returned -5.40% for the same period. Fixed-income ETFs have decoupled from the underlying indices, posting even greater losses. The overall broad muni bond ETF MUB is showing a year-to-date return of -3.95% as compared to a loss of 0.94% on the Bloomberg Barclays Broad Muni Index.
The spike in yields can be attributed to massive selling predominantly by banks, ETFs and mutual funds. The bank liquidations were part of broader effort to free up cash and increase liquidity. Mutual funds and ETFs were severely impacted by a reversal of fund flows. After 59 weeks of positive flows into muni mutual funds, Lipper reported a weekly outflow of $1.8 billion. Negative performance in select mutual funds may have been caused by short U.S. Treasury positions that were intended to hedge duration. However, they instead were negatively impacted by the rally in the U.S. Treasury market.
We believe that the new valuations may present a buying opportunity in select high-quality, non- cyclical credits. On an absolute basis, the ratio of muni-to-Treasury of over 175% to 180% are some of the most attractive valuations we have ever seen—in some cases even higher than the previous high during December 2008. The most important point for OIA tax-exempt clients to understand is that the credits they own in the portfolio are some of the highest credit-quality bonds. Also, the movement in rates is not a reflection of deteriorating credit fundamentals, but instead technical market imbalances. These higher levels in interest rates present good yields for investors who will benefit in the long term.
Additionally, we believe the SMA structure of the accounts affords the client a level of stability relative to the commingled funds and ETF investments. While they have participated in a degree of market volatility, the separate and transparent account structure has insulated investors from the worst of the market correction.
Tax-exempt municipal bonds are issued by state and local governments as well as other governmental entities to fund projects such as building highways, hospitals, schools, and sewer systems. Interest on these bonds is generally exempt from federal taxation and may also be free of state and local taxes for investors residing in the state and/or locality where the bonds were issued. However, bonds may be subject to federal alternative minimum tax (AMT), and profits and losses on bonds may be subject to capital gains tax treatment. Municipal securities may lose their tax-exempt status if certain legal requirements are not met, or if tax laws change. The financial condition of the issuer may change over time and it is important to monitor the changes because they may affect the ability of the issuer to meet its financial obligations.
The MSRB's EMMA website allows investors to sign up to receive alerts about the availability of important information that may affect their municipal bonds. The MSRB makes official statements and continuing disclosures submitted to it by issuers and others available to the public for free through its EMMA website. EMMA also provides municipal securities trade price information through its Real-time Transaction Reporting System ("RTRS") and free public access to certain municipal credit ratings. See more here
Special Risks of Fixed Income Securities: There is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time. Liquidity risk refers to the risk that investors won’t find an active market for a bond, potentially preventing them from buying or selling when they want and obtaining a certain price for the bond. Many investors buy bonds to hold them rather than to trade them, so the market for a particular bond or a small position in a bond may not be especially liquid and quoted prices for the same bond may differ.
© 2020 Oppenheimer Asset Management Inc. This commentary is intended for informational purposes only. The information and statistical data contained herein have been obtained from sources we believe to be reliable. Oppenheimer Investment Advisers (OIA) is a division of Oppenheimer Asset Management Inc. The opinions expressed are those of Oppenheimer Asset Management Inc. (“OAM”) and its affiliates and are subject to change without notice. No part of this presentation may be reproduced in any manner without the written permission of OAM or any of its affiliates. Any securities discussed should not be construed as a recommendation to buy or sell and there is no guarantee that these securities will be held for a client’s account nor should it be assumed that they were or will be profitable.
Past performance does not guarantee future comparable results. Neither OAM nor its affiliates offer tax advice .Investors should consult their own tax advisors and counsel. OAM is a wholly owned subsidiary of Oppenheimer Holdings Inc. which also wholly owns Oppenheimer & Co. Inc. (“Oppenheimer”), a registered broker/dealer and investment adviser. Securities are offered through Oppenheimer and will not be insured by the FDIC or other similar deposit insurance, will not be deposits or other obligations of Oppenheimer or guaranteed by any bank or other financial institution, will not be endorsed or guaranteed by Oppenheimer and will be subject to investment risks, including the possible loss of principle invested.
High yield fixed income securities are considered to be speculative and involve a substantial risk of default. Adverse changes in economic conditions or developments regarding the issuer are more likely to cause price volatility for issuers of high yield debt than would be the case for issuers of higher grade debt securities. In addition, the market for high yield debt may be less attractive than that of higher-grade debt securities