The January effect, which started strong, ended quietly by the end of the month. Larger than expected supply, and what appears to be a Trump muni hangover, kept a strong rally in munis from occurring for maturities longer than 7 years. Munis represent good value, but we feel weaker technicals are on the horizon, and munis will get a little bit cheaper before things get better.
The final quarter of 2016 was a wakeup call for 2017. A combination of high issuance and increased political risk caused yields to increase over 70 bps during the final months of 2016. These concerns remain in in 2017. This month, we look at some muni market charts that show us a quick picture of 2016 and could be important in 2017.
Muni Market Review:
The January effect was very quiet in 2017 versus historical standards. January in muniland is usually defined by a large amount of cash from coupon and maturity payments chasing a low supply of new bonds. We feel lingering fears of Trump policies and a larger new issue supply then normal (27% higher than 2016) caused munis to underperform taxables. Highlights for January are as follows:
- Muni rates changed from -16 to +11 bps with the curve steeping.
- Taxable rates changed +1 to +4 bps, outperforming munis greater than 10 years in maturity.
- The strong performance of the short-end of the muni curve confirms that investors are still not certain of what to expect from the Trump administration.
- Munis still represent good long-term value, but as we move to March, and technicals weaken, there may be attractive purchase opportunities.
MMD default statistics for 2016 show the following:
- In 2016, 64 issuers defaulted for a total par amount of $27.32 billion. On a rough count basis, $24 billion of the 2016 total is from defaulted Puerto Rico issuers.
- In 2015, 60 issuers defaulted for a total par amount of $3.94 billion.
- Excluding Puerto Rico, the amount of defaults from 2015 to 2016 was largely unchanged.
We are looking for 2017 to be another year of high issuance, with no real big move up in interest rates and, like the last quarter of 2016, increased price volatility. We would encourage investors to be prepared for income enhancement trades during the course of 2017. This entails selling prerefunded and buying longer-term bonds when the market becomes illiquid. The prerefunded bonds have proven to maintain liquidity during market stress, when the rest of the market is trying to catch a bid. We also encourage investors who have been holding cash to be prepared to buy on weakness.
Market News & Credit Update:
December unemployment rates are in, and the states with the lowest rates are: New Hampshire, Massachusetts, South Dakota, Hawaii, and Colorado. The states with the highest rates are: West Virginia, Louisiana, Alabama, New Mexico, and Alaska.
It appears the “Exceptional Drought” in California may finally be coming to an end. Since January 2014, the state has been in the most serious drought category, but recent storms have nearly 39% of the state now considered drought free.
Since July 2015, Illinois has been operating without a budget. Both political parties have been working out compromises, but have not been able to get the votes needed in the state senate to approve a new budget. The compromises include: an increase in income tax from 3.75% to 4.95%, the sale of over $7 billion in bonds to pay off back bills, and a raise in the minimum wage. Unfazed with what seems to be progress, Fitch downgraded the state’s credit rating from BBB+ to BBB. S&P has the state rated BBB, and Moody’s Baa2. Both have negative outlooks.