Western Asset examines recent trends in the muni bond market and provides its outlook about conditions ahead.
- The Bloomberg Barclays Municipal Bond Index posted a negative total return of -0.36% in April; a full reversal of the +0.37% gain in March.
- However, the muni index held up better than the Bloomberg Barclays U.S. Aggregate Bond Index (the benchmark for the taxable market), which returned -0.67%.
- For the year-to-date period, the muni index was down -1.46%, less than the -2.19% for its taxable counterpart.
- Meanwhile, high yield municipal bonds outperformed investment grade bonds as the Bloomberg Barclays High Yield Municipal Index posted a return of +0.45% in April and was up +1.03% for the year.
- In general, munis are off to a weak start so far this year; however much of the weakness can be linked to softness spilling over from the U.S. Treasury market, and more importantly is not a reflection of fundamental credit struggles in public finance. In our opinion, credit fundamentals in the muni market look generally solid.
Revenue bonds outperformed G.O. bonds in all periods shown below
Source: Bloomberg Barclays, as of 4/30/18. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. For illustrative purposes only and does not represent the performance of any specific investment product.
- While selling in the secondary markets remains active, a healthy balance exists between new issue supply and demand and that’s another factor that leads us to believe that munis will find their way out of this lackluster landscape.
- New issues were generally well spoken for throughout the month despite open end mutual funds experiencing negative flows during April, which is not very surprising considering flows are usually challenged during tax season when clients sell assets to raise cash for their taxes.
- Total issuance for the first four months of 2018 is down 23% relative to the first four months of 2017.
- We believe a modest increase in supply would actually prove beneficial for the market, as sometimes supply generates demand and improves price discovery.
Muni issuance: 2018 vs. 2017
Source: Bloomberg Barclays, as of 4/30/18.
Monthly net new cash flows into long-term muni funds and ETFs
Source: Source: Investment Company Institute, Washington DC, as of 5/02/18. February flows are estimated as of the week ending 4/25/18.
- In our opinion, the muni market is offering attractive yield ratios, which is beginning to attract renewed investor interest.
- The 10-year AAA muni to US Treasury ratio is 86%, and on the long end is 101%.
Yield Curve Comparison: BBB Muni Revenue, AAA Muni & US Treasury
Source: Bloomberg Barclays, as of 4/30/18. Past performance is no guarantee of future results. For illustrative purposes only and does not represent the performance of any specific investment product.
Muni/Treasury Ratios and Taxable Equivalent Yields
Source: Bloomberg Barclays, as of 4/30/18. Past performance is no guarantee of future results. For illustrative purposes only and does not represent the performance of any specific investment product. Taxable Equivalent Yield (TEY) is based on 37% top tax bracket. An investor may be subject to the federal Alternative Minimum Tax, and state and local taxes may apply. Capital gains, if any, are fully taxable.
- Broadly speaking, the economy continues to expand at a modest pace and inflation remains controlled.
- The underwhelming performance of the municipal bond sector so far this year has only improved municipal bond attractiveness, in our opinion.
- We continue to like intermediate- and long-term bonds with positive convexity and that offer attractive yield versus high quality securities.