A Harvard University graduate wears a masks on campus.
Craig F. Walker/The Boston Globe through Getty Images
Municipal bonds outperformed Treasurys in June and they may proceed to see good demand this summer time, even because the pandemic limits financial exercise and strains state budgets.
The muni market was hit onerous throughout the market collapse in February and March, and the $3.eight trillion asset class has not totally recovered. Strategists say it could possibly be topic to more volatility, relying on the course of the virus and the economic system.
Bank of America says that munis have underperformed all U.S. taxable bond indexes within the first half on an after-tax foundation, making munis the most cost effective asset class.
“We are positive on the recovery of the prices, but there will still be more downgrades. That’s the cautious part,” mentioned Yingchen Li, Bank of America co-head municipal analysis.
Strategists say a catalyst for the market this summer time ought to be one other spherical of stimulus from Congress, within the type of direct help for state and native governments.
While munis returned about 2% within the first half of 2020, based on the Bloomberg Barclays Municipal bond index, not all bonds are created equal, and the affect of the financial hit from the coronavirus is affecting issuers in a different way.
“In terms of the bond market and muni market itself, we think investors should be focused on higher rated issuers,” mentioned Cooper Howard, director of mounted revenue technique at Schwab Center for Financial Research. “We think there are opportunities to dip into single A rated credits, of issuers in sectors that have stable revenues.”
Many traders purchase funds and ETFs, and strategists say a portfolio of muni bonds ought to be various. That means they ought to include a combination of bonds, like state and metropolis basic obligation bonds, plus bonds from different varieties of issuers like water and sewer authorities, the very best performers up to now this 12 months, based on Bloomberg Barclays knowledge.
Those with the bottom returns within the first half embody hospitals and transportation, which embody transit programs and airports.
The market has been helped each by fiscal help underneath the CARES Act and by a Federal Reserve program focused to help the muni market.
Jeffrey Lipton, head of Oppenheimer municipal analysis and technique, mentioned munis have been up 82 foundation factors overall in June, whereas U.S. Treasurys returned simply 9 foundation factors.
“Right now, we’re going through the seasonal technicals, where you have outsized demand, but you don’t have supply to meet the demand. That’s part of what’s driving performance, the market technicals,” mentioned Lipton. “But also the fact that you’ve had rather aggressive, appropriate and scalable monetary and fiscal policy. That taken together has alleviated much liquidity concerns, as well as credit concerns in the municipal market.”
Congress to the rescue?
Congress is anticipated to contemplate the following section of stimulus later this month to assist state and native governments take care of the finances pressure from the virus, coupled with a lack of income.
While Democrats have focused $1 trillion for state and native governments, political strategists say the quantity will more doubtless be much less than half of that.
“If they get more money, it will be enough,” mentioned Ian Rogow, co-head of muni analysis at Bank of America, together with Li. Rogow mentioned state and native governments got here into the disaster well-positioned by way of reserves. “2019 was one of the strongest ratings years in the post-financial crisis era…To the extent, they get a decent amount of funding from Congress, it will forestall the worst budget cuts.”
BofA strategists mentioned GO bonds outperformed the income index as important companies, which embody schooling, water and utilities have been robust. But airports, transportation, multi-family, rental abd lease and healthcare have been weak.
For the second half, they see little motion in AAA charges but credit score spreads ought to slender additional in July.
Li mentioned munis are nonetheless undervalued by one vital metric. He mentioned the distinction between the yields of the very best rated funding grade AAA munis and the bottom funding grade, BBB, are nonetheless about 60% wider than they have been when the market began to unload in February.
State finances points
As for state bonds within the first half, the underperformance of Illinois, New Jersey and New Hampshire weighed on the class. New Jersey and Illinois have finances points and excessive pension obligations.
Howard mentioned New Hampshire bonds are tied to hospitals, a gaggle that bought slammed throughout the market sell-off as traders reacted to fears concerning the virus affect.
Know the dangers
Investors ought to watch out for potential scores downgrades, but additionally bankruptcies although they are uncommon within the muni world.
BofA cited a examine by Moody’s that discovered there have been simply 113 defaults for Moody’s rated muni issuers between 1970 and 2018. About 60% of these defaults have been in well being care and housing. There have been solely 10 GO defaults by faculty districts, counties or cities throughout that very same time, and none involving states, which can not go bankrupt.
BoA strategists say among the many bonds they like are cities which have a excessive publicity to the expertise sector, and they advise traders to keep away from excessive yield and small non-public faculties. They additionally anticipate the taxable munis to outperform the tax free this summer time.
Schwab’s Howard mentioned he favors a portfolio of GO bonds and important companies income bonds, like water authorities which have assured income streams.
Education bonds alternatives
Investments within the schooling sector, about 7% of the funding grade market, slot in a balanced portfolio.
But the affect of the coronavirus has put a pressure on colleges, and Howard mentioned traders must discern between how completely different colleges are rated and the way they are positioned to climate a 12 months the place they might accumulate much less revenues and spend more to supply schooling in a Covid world.
The outlook is even more difficult by the uncertainty concerning the subsequent semester and the completely different approaches colleges and states are taking to classroom studying. Some college students might discover they might take a spot 12 months, leaving some colleges in need of income.
The Trump administration is requiring worldwide college students to bodily attend courses or go away the nation. For some colleges, tuition from these college students is an vital a part of their revenues. Both MIT and Harvard University sued the Trump administration Wednesday over the ruling.
Strategists say even earlier than the coronavirus, it was typically safer to stay to the bonds of Ivy League colleges and nationally acknowledged model title colleges over smaller non-public establishments. Public colleges are usually increased rated, normally within the A+ class, but non-public colleges scores are more wide-ranging.
Public establishments are separate credit score entities from their states, but they profit from the actual fact they have state funding. They may additionally come underneath strain as a result of state budgets are pinched and better ed is a spot to look for cutbacks.
Schwab mentioned public universities accumulate about 22% of their revenues from state help. Another 48% is pupil generated income, but about 85% of personal faculty revenues are pupil generated.
“In higher ed, the bifurcation plays out in those that are higher rated, those tend to be schools with huge national draws or niche markets, versus the smaller private school with heavy dependence on tuition. That’s where I’d be cautious,” mentioned Howard.
Howard mentioned the schooling bonds have been lumped collectively so there is alternative for traders keen to differentiate between them.
Strategists say that is additionally true of different sectors that have been crushed down, and traders ought to look for the higher names within the hospital and transportation teams, for instance.