Municipal Bonds: Driven by Individual Investors

Income-seeking retail investors are driving the market for municipal bonds, but a disciplined approach can still uncover opportunities.

May 17, 2018


This Municipal Bonds sector report is excerpted from the Second Quarter 2018 Fixed-Income Outlook.

Long-dated municipal bonds outperformed Treasurys in the first quarter, and remained attractive relative to investment-grade corporate bonds on a taxableequivalent basis. We expect long Treasury rates will continue to drive tax-exempt municipal bond performance as higher rates beget higher relative value of tax-exempt yields. With a long duration bias, the municipal market is uniquely sensitive to an investor base disproportionately represented by individual investors compared to other fixed-income asset classes. As such, return-chasing behavior commonly found among retail investors has proved a stronger driver of performance than developing trends in credit fundamentals.

Tax-Exempt Municipal Bond Fund Flows Are Linked to Performance

Return-chasing behavior commonly found among retail investors has proved a stronger driver of performance than developing trends in credit fundamentals.

Tax-Exempt Municipal Bond Fund Flows Are Linked to Performance

Source: Bloomberg Barclays Municipal Bond Index, Investment Company Institute, Guggenheim Investments. Data as of 3.31.2018. LHS = left hand side, RHS = right hand side.

Primary new-issue supply declined 13 percent year over year, and we expect persistent low supply levels to provide a supportive technical backdrop in 2018 and beyond. Absent a political catalyst, supply expectations for the next few years are constrained by the elimination of advanced refunding bonds and the consequences of supply patterns from the prior decade. We expect softer supply through 2020 due to the 10-year anniversary of the 2009–10 Build America Bond program, which replaced significant portions of long-dated taxexempt bonds that would have been callable and funded by refunding supply.

The Bloomberg Barclays Municipal Bond index posted a 1.1 percent loss in the first quarter of 2018, with longer-maturity bonds significantly underperforming the short-end as rates increased. Losses were fairly evenly distributed by rating, with AAA-rated bonds down 1.2 percent, AA-rated and A-rated bonds down 1.1 percent, and BBB-rated bonds down 1.0 percent for the quarter.

Technical factors will likely continue to dominate the municipal market’s attention, but we emphasize the need to maintain credit discipline, understanding that systemic and idiosyncratic credit risk will be pushed to the forefront in the next recession, which our Macroeconomic Research and Investment Group estimates will begin in late 2019 to mid-2020. We continue to favor higher-quality revenue bonds from issuers that are fundamentally sound on a standalone basis.

Upcoming 10-Year Call Periods of Tax-Exempt Bonds Temper Supply Outlook

We expect persistent low supply levels to provide a supportive technical backdrop in 2018 and beyond. We also expect softer refunding supply through 2020 due to the 10-year anniversary of the 2009–10 Build America Bond program, which replaced significant portions of new money long-dated tax-exempt bonds that would have been callable and refunded.

Upcoming 10-Year Call Periods of Tax-Exempt Bonds Temper Supply Outlook

Source: The Bond Buyer, Guggenheim Investments. Data as of 12.31.2017.

—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director; Michael Park, Vice President

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


FEATURED PERSPECTIVES

Forecasting the Next Recession: The Yield Curve Doesn’t Lie - Featured Perspectives
October 29, 2018

Forecasting the Next Recession: The Yield Curve Doesn’t Lie

Our Recession Probability Model and Recession Dashboard continue to suggest a recession is likely to begin in early 2020. Investors ignore the yield curve’s signal at their peril.

Beneath the Tide of Rising Earnings - Featured Perspectives
October 15, 2018

Beneath the Tide of Rising Earnings

Factors that have contributed to strong earnings growth this year will fade in 2019 and turn into headwinds in 2020, exposing leveraged corporate borrowers.

Tail Risks Are Getting Fatter - Featured Perspectives
August 20, 2018

Tail Risks Are Getting Fatter

While the U.S. economy remains on solid footing, exogenous risks threaten asset values, market confidence, and the strength of the U.S. economy.


VIDEO

Forecasting the Next Recession 

Forecasting the Next Recession

Global CIO Scott Minerd and Head of Macroeconomic and Investment Research Brian Smedley provide context and commentary to complement our recent publication, “Forecasting the Next Recession.”

Macro Themes to Watch in 2018 

Macro Themes to Watch in 2018

In his market outlook, Global CIO Scott Minerd discusses the challenges of managing in a market melt up and highlights several charts from his recent piece, “10 Macro Themes to Watch in 2018.”







© 2018 Guggenheim Partners, LLC. All rights reserved. Guggenheim, Guggenheim Partners and Innovative Solutions. Enduring Values. are registered trademarks of Guggenheim Capital, LLC.