value bond picking as a tonic for hyper political focus
Tom Dalpiaz, Managing Director (April 13, 2017)
There’s an old saying, “Never discuss politics and religion in polite company.” This is usually sound advice. There are times, however, when not discussing politics and government policy can become quite difficult. In terms of assessing present and future financial market behavior, this has been one of those times. While politics and government policy have always impacted economic growth, inflation, and interest rates, the arrival of a new presidential administration will usually heighten the impact that politics can have on financial markets, at least for a while. It’s safe to say market interest in political and governmental forces has been more intense this particular cycle.
The notion that tax law would be changed with the new administration’s passage of broad tax reform (generally unfavorable for municipal bonds) helped to drive muni bond yields substantially higher last November. The inability of Congress and the President to quickly repeal and replace the Affordable Care Act last month made the markets reconsider how quickly the positives or negatives expected from the new administration might arrive, if at all. In the first quarter, both bonds and stocks reversed some of their previous sharp reactions of last November.
Tax reform is one of the major initiatives from the new administration the financial markets have been waiting for and one that could impact municipal bonds in a meaningful way, although I still believe the negative impact is likely to be comparatively less in the short and intermediate maturity spaces. My past commentaries have highlighted my view that broad tax reform is quite complex with potentially sizable consequences for the federal budget and major sectors such as housing and non-profits. There is a reason major, broad-based tax reform was last done thirty years ago and that it took a number of years to hammer out and become law. Given the complexity of tax reform and the politics involved, it remains to be seen what kind of tax reform, if any, we will be getting in the near future. I believe it is not wise to fashion investment decisions based on tax reform suggestions and proposals at this time, particularly in the muni bond space.
In terms of total return, the municipal bond market in the first quarter of 2017 was fairly strong, probably stronger than many expected it to be. The total return for the Barclays 7-Year Municipal Bond Index in the first quarter was +1.95%. The intermediate maturity area was one of the stronger performing parts of the yield curve, doing somewhat better than the Barclays Long Muni Bond Index in the first quarter. This reasonably strong performance occurred in spite of the Federal Reserve telegraphing and implementing another Fed Funds rate increase. The strong tone to the muni market can be explained by two things: relatively light supply of new issue municipal bonds throughout the quarter and the receding specter of quick (and negative) tax reform. My generally defensive posture in terms of maturities and bond structure still allowed the Granite Springs Intermediate Municipal Strategy to garner a large portion of the upside in a relatively strong quarter for the muni market. I am comfortable with the approach and the portfolio structure going forward given the likelihood of gradually increasing rates for 2017 and beyond.
While politics and governmental policy will still impact expectations and the direction of interest rates throughout 2017, it is important to not get too caught up in every turn of fortune in the political arena. Investors should also keep an eye on Federal Reserve policy and on hard data regarding economic growth and inflation. I believe one of the most difficult things to do right now as an investor is to try to determine how much of the market’s direction can be attributed to expectations of new government policy and how much is supported by actual economic and inflation data. Of course we just cannot know for sure. Perhaps just remembering that both kinds of forces can impact interest rate movements should act as a tonic of sorts to a distracting hyper-focus on political events. I remain a big believer of ferreting out value at any point in the interest rate cycle. The inefficiencies of the municipal bond market continue to exist and await discovery by a seasoned bond picker.
Tom Dalpiaz manages an intermediate municipal bond strategy at Granite Springs Asset Management. The Intermediate Municipal Bond strategy was launched in September 2009.
Granite Springs Asset Management, LLC is a privately held SEC-registered investment advisor that specializes in fixed income portfolio management and tactical asset allocation investment strategies for private clients, family offices, financial advisors, insurance companies, pension plans, and other institutional investors. Granite Springs Asset Management, LLC is a Registered Investment Advisor with the U.S. Securities and Exchange Commission and qualified to do business in various state jurisdictions where required.
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