July 2016 Municipal Bond Market Commentary

It’s Always Something…

Tom Dalpiaz, Managing Director (July 8, 2016)

[PDF Version]

Given recent surprises in international events and market volatility, it is probably a good time to trot out the old saying, “Now is always the hardest time to invest.”  That quote was first stated 80 years ago by Bernard Baruch, financier and presidential advisor.  It still resonates.  The timeless wisdom of that quote reminds us how common it is for investors to hesitate when investing because of their view that each environment is uniquely fraught with uncertainties.  The quote reflects the observation that it always seems possible to compile a list of uncertain and puzzling factors that could reasonably convince investors to sit on the sidelines.  In the words of Roseanne Roseannadanna, a Gilda Radner character from early Saturday Night Live skits, “It just goes to show you, it's always something — if it’s not one thing, it's another…”

The wisdom behind “the hardest time to invest” quote does not dismiss the fact that investors in the past have had truly difficult times in which to invest.  Market participants may be facing such a time now.  Prompted by Great Britain’s generally unexpected vote in late June to leave the European Union, the flight to quality in the Treasury bond market has pushed interest rates down to historical lows.  A less-than-exciting payroll employment number in early June had already lowered rates by dampening expectations of a near-term Fed-engineered rate rise.  Municipal bond yields have fallen as well, but not nearly to the same degree as Treasuries.  High grade municipal bond yields in the ten-year maturity range are 97% of ten-year Treasury bond yields, the highest since March of this year.

In my January commentary this year, I suggested the fundamentals of the muni market would be generally strong throughout much of 2016 and it has played out that way so far.  The steady demand for municipal bonds continues unabated as evidenced by sustained, week-after-week net positive inflows into muni bond funds and ETFs.  The supply of new issue municipal bonds was somewhat higher in the second quarter of this year but still slightly behind year-to-date in comparison to last year.  These strong fundamentals and generally falling rates have produced attractive total returns so far in 2016.  The Barclays 7-Year Muni Index has a year-to-date total return of 3.30% while the Barclays 10-Year Muni Index has returned 4.56%.   The Barclays Long Muni Bond Index is up 6.99%.  As if all that wasn’t enough, negative bond yields globally have begun to make global investors a growing source of demand for municipal bonds as well.  While a buyer’s strike due to low yields and a surge in new issue supply are always possible, I suspect strong fundamentals for the muni market are likely to continue for the rest of the year.

In my April commentary, I suggested that the key focus word for investors might be “gradual.”  Maybe now “inscrutable” should be the word.  Major uncertainties abound in European politics and trade, the price of oil, the pace of Chinese economic activity, our own domestic politics and prospects for economic growth, and Federal Reserve monetary policy.  These are indeed difficult markets to assess.  I started out my January commentary by noting a strong market consensus that surely this would be the year (finally, after so many false predictions) of rising rates.  That early January, “no-brainer” view of rising rates doesn’t seem so obvious now.  This is a useful reminder of how markets can easily confound carefully reasoned market consensus.

What are investors to do?  In difficult markets such these, it may be helpful to step back and consider a few simple observations.  Investment environments always contain uncertainties of various degrees.  Waiting on the sidelines for uncertainties to clear may result in waiting for a market clarity that never materializes.  Markets are rarely that accommodating.  Extended waiting carries a cost and turns investors into timers (and thus players in a game they’re unlikely to win consistently).  Earning something rather than close to nothing on investments will at least move market participants down the road toward achieving their investment objectives.  Investors can only work with the markets that are given to them and they should compare available investment alternatives on an after-tax and risk-adjusted basis.  Do not confuse the general thought that interest rates may rise (and that all fixed income is bad) with how a particular subsector and maturity range within the fixed income universe is likely to behave in difficult markets.

None of these observations are likely to cause investors to get overly excited and jump in with both feet to scoop up the historically low yields they currently face.  It is easy to understand today’s investor reluctance and caution.  Perhaps the thoughts outlined above can provide perspective and a rationale for staying engaged in challenging markets in a careful and deliberate way.  Perhaps stepping back and focusing on simple observations is what’s required when an abundance of uncertainty threatens to produce investor paralysis.  I continue to suggest that carefully selected and managed investment grade/intermediate maturity municipal bonds can help solve investment problems -- even through the uncertain and puzzling markets likely to dog us for the remainder of this year.

July 1st has come and gone and, as expected, Puerto Rico did indeed miss some principal and interest payments on its debt.  There has been no detrimental effect on the municipal bond market as a whole since Puerto Rico’s troubles have been well-known for some time and the likelihood of missed payments well-incorporated into the market’s thinking.  The muni bond market is tremendously large and diverse in the number and types of bond issuers.  Puerto Rico notwithstanding, literally thousands and thousands of municipal bond issuers continue to go about the daily work of honoring their obligations.

Puerto Rico bond prices reacted immediately in a positive way to the Federal legislation (PROMESA) that was passed by Congress and signed by the President at the end of June.  The main feature of the legislation was the creation of an oversight control board that will oversee negotiations with creditors, the creation of a fiscal plan, the adequate funding of the island’s pensions, and the restructuring of its debt.  It is simply unknowable right now just how these negotiations and restructurings will play out and how Puerto Rico bond prices will be affected in the future.  Most analysts and market participants agree that problems as large and long-standing as Puerto Rico’s have many contributing factors and therefore require multi-pronged solutions and participation from a number of players for real recovery to occur.  PROMESA’s oversight control board is a necessary first step in providing the island with some relief, some time, and outside stewardship to make difficult financial decisions.  For Puerto Rico, as with any municipal bond issuer, the vibrancy of the service area (demographics, economic activity, tax structure, income levels, and social factors) ultimately will drive the revenues it can capture for appropriate government activities and debt repayment.  More solutions in that area need to be offered and agreed upon for Puerto Rico to experience complete recovery.


Tom Dalpiaz manages an intermediate municipal bond strategy at Granite Springs Asset Management.  The Intermediate Municipal Bond strategy was launched in September 2009.

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