May 2017 Municipal Market Review- Revisiting “A Time to Buy & A Time to Sell”:
Some things never change. The sun comes up in the east, sets in the west. The state of Illinois is a fiscal and political mess, and the state of California tax revenue trend remains a leading economic indicator. Now, there is one more thing we can add: muni issuers sell a majority of their bonds when demand from coupon and maturities payments are at their lowest. We have followed this trend since 2009, and it has not changed. What does this mean to a patient investor? It means better long-term investment value and better selling liquidity.
The muni market is set up for a good summer of performance, as supply and demand technicals (see “A Time to Buy & A Time to Sell”) are bullish and tax reform looks harmless – if it even gets addressed. The current estimate is $39.5 billion of excess demand versus supply over the next 60 days. That being said, if you are looking to raise cash, the next 30 to 90 days may be a good time. We are here if you need us.
Muni Market Review:
The municipal market in the month of May was defined by low volume. As a result, the month showed strong muni performance, as falling interest rates and a favorable supply/demand dynamic helped municipal bonds notch their sixth straight month of positive returns. Highlights from a strong May are as follows:
- Muni rates changed from -8 to -29 bps, with a strong showing across the entire curve.
- Taxable rates changed -1 to -12 bps.
- To date, 2017 issuance is lagging 2016’s record levels. Refunding volume is down, due to the rise in interest rates causing overall issuance to be down $22.5 billion year-to-date, and 16.9% versus March 2016. This lower level of issuance is only going to increase over the next 60 to 90 days, which should help the muni market outperform.
Market News & Credit Update:
Kroll Bond Rating Agency released a report discussing the recent trend in municipal bankruptcies. They voiced concerns that muni investors are being treated differently than they have been in the past. They are now “particularly vulnerable in this more adversarial, zero-sum environment”. We agree with their concern, especially in the case of limited and unlimited General Obligation debt and feel no GO bond should be bought without credit due diligence.
Is Illinois playing “chicken” with the capital markets? The state has until May 31st to pass a budget (now three years late) with just a majority vote, which it has not been able to do. As of June 1, it will need a 3/5 vote. In the meantime, credit ratings for issuers dependent on state aid keep going down, and unpaid bills continue to pile up. The state now has $14.5 billion of unpaid bills. Not sure how this downward spiral credit trend is going to end, unless the “windy state” can put it politics aside.
Revenue growth in California has begun to slow, and forecasts for budget deficits are returning. Of bigger concern would be a rollback of Obama care since the state receives more funds than any other. Both of these concerns for lower state revenue has Governor Brown and state legislators reviewing ways to help temper the effects on the state’s budget. The state has historically been known as having a boom/bust credit profile. This appears to have not changed and may be still be a leading indicator for the US economy. This doesn’t mean the “California Freedom Coalition” will now get the votes it needs to secede from the USA.
When to buy and when to sell – A Revisit to The Seasonal Effects on the Municipal Market:
Introduction:
This is an update to an analysis first done in 2009, reviewed in 2013 and now, using ten years’ worth of data, (2006 to 2016) we review it again. We wanted to update the analysis to see if there has been a change in the seasonal flow of funds on the municipal market. When we discuss seasonal supply/demand technicals in our monthly review, this is usually the information we are evaluating.
Background:
The municipal market is a vehicle used to finance the needs of the public (supply). An investor in muni bonds does so to realize tax exempt income (demand). This creates the necesarry supply, countered by a demand that can be controlled.
Supply in this analysis is represented by the issuance of municipal bonds. Municipal issuers sell bonds to fund long-term public projects that are needed and approved by its citizens. The need to finance these projects is not so much market driven (cost versus reward), but is more so for the importance of the services that the project provides. The residents have determined the service is needed and, therefore, the quicker it is provided, the better. Most municipalities’ fiscal years begin and end in June/July and/or December/January. This is when most new bond issues are approved and underwritten.
Demand in this analysis is represented by bond maturities and bond refunding payments received by investors. This creates a “natural demand”, as long-term municipal investor will have proceeds from these sources to purchase new bonds.
To see what type of seasonal patterns exist with municipal bonds, MainLine analyzed municipal bond issuance (supply) and bond maturities and refunding (demand) from 2006 to 2016 to look at the seasonal patterns of each.
Conclusion:
This analysis shows a disparity between supply and demand on a seasonal basis, which can create market opportunities for the patient investor. More specifically:
- May to August, and December, demand far outpaces supply (53% versus 42% of annual volumes). This would tend to be a good market to sell bonds as on average there is $25 billion of additional demand (cash) in the market.
- March to April, and September to November, supply outweighs demand (45% versus 32% of annual volumes). This would tend to be a good market to buy bonds as supply outstrips natural demand by over $58 billion.
Once again, the seasonal effect of muni supply and demand remains strong. As an investor, if you can remain patient, you can take advantage of this structural anomaly. Picking the right time to buy or sell a bond can provide savings that will last the life of the bond through increased buying yield, or higher selling proceeds. This appears to have not changed in seven years, and there is nothing showing us it will change anytime soon.