Are Munis Oversold? We Think So - Context

TERRY HULTS:

The municipal market has just been through a very tough month. The broad index is down almost 4%. And so the question for investors is whether, years from now, when they look back at this time period, November of 2016, will it get added to the list of time periods where the markets sold off very quickly and then rebounded as a representative buying opportunity of sorts?

We’ve been seeing increased supply. Then we had the volatility in rates in general.

Treasury yields rising 50 or 60 basis points in November because the world became more concerned with the inflationary impacts of Trump’s fiscal policies. That created volatility in the rates market, bled into the municipal market, combined with the impact of a proposed lower tax rate, led to one of the worst single months in the municipal market going all the way back to 1994.

So the question again is whether this is a buying opportunity—what’s the magnitude of it? Usually, given the limited investor base of the municipal market, we quite often see these periods of quick movements. We saw it this time: over five billion dollars of outflows in municipal bond funds. At this point, given the relative cheapness of municipal bonds, given the fact that the very same borrowers’ bonds in many cases trade in the tax-free market at higher absolute yields, even though they’re tax free, than where their very bonds trade in the taxable market—is creating interest from crossover buyers, buyers who don’t generally care that much about the municipal market. In many cases they don’t even pay taxes, but now they’re looking at it because of the relative cheapness. We’re just starting to see that, and I think if these relationships persist we’ll see more and more of it.

The technicals are set up to improve. We have a record amount for the month of December of bonds maturing, being redeemed out of the market, and coupon payments hitting over 40 billion dollars. We’ll see good cash flow coming into the market in January. And supply, of course, as we get into the holiday period and the beginning of next year, will be very light. So we think the technicals are improving.

And, of course, the fundamentals, if you believe the new administration’s policies will lead to economic growth. Economic growth is good for tax revenues; it’s good for municipal credit.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.