Muni bonds surge as Trump’s aims stall

Northwest Arkansas Democrat-Gazette - - BUSINESS & FARM - PAUL J. LIM

Mu­nic­i­pal bonds were sup­posed to be among the big­gest losers un­der a Don­ald Trump pres­i­dency.

Shortly af­ter the Novem­ber elec­tion, muni bonds — is­sued by states, mu­nic­i­pal­i­ties and lo­cal agen­cies to fi­nance gov­ern­ment projects — faced a “triple whammy,” said Terri Spath, chief in­vest­ment of­fi­cer at Sierra In­vest­ment Man­age­ment.

First, there was a sharp rise in mar­ket in­ter­est rates late last year in an­tic­i­pa­tion of the new Trump poli­cies help­ing eco­nomic growth. And ris­ing rates are a head wind for bonds in gen­eral. Then there was the pres­i­dent’s pledge to lower in­come tax rates, cou­pled with con­cerns that he might elim­i­nate the tax-ex­empt sta­tus of mu­nic­i­pal bond in­come.

And fi­nally, Trump has promised to in­crease in­fras­truc­ture spend­ing by pos­si­bly $1 tril­lion — which, if it hap­pens, could flood the muni mar­ket with ad­di­tional sup­ply, weigh­ing on the price of ex­ist­ing mu­nic­i­pal bond se­cu­ri­ties.

But it hasn’t turned out that way so far.

“Here we are, sev­eral months later, and the ad­min­is­tra­tion has had prob­lems get­ting any­thing done,” said Ni­cho­los Ven­ditti, a port­fo­lio man­ager who helps run sev­eral mu­nic­i­pal bond funds at Thorn­burg In­vest­ment Man­age­ment. “There’s been no health care re­form yet, no tax re­form and no clar­ity on spend­ing.”

Mean­while, con­cerns about a slow-grow­ing econ­omy have resur­faced, push­ing the yield on 10-year Trea­sury notes back down to 2.3 per­cent at the end of June, from as high as 2.62 per­cent in March.

And the Trea­sury sec­re­tary, Steven Mnuchin, re­cently told the Se­nate Fi­nance Com­mit­tee that the Trump ad­min­is­tra­tion sup­ported pre­serv­ing the mu­nic­i­pal bond tax ex­emp­tion.

The re­sult of all of these devel­op­ments is that muni bond mu­tual and ex­change­traded funds have en­joyed a sur­pris­ingly good run this year.

For in­stance, the SPDR Nu­veen Bloomberg Bar­clays Mu­nic­i­pal Bond ETF, whose big­gest hold­ings in­clude rev­enue bonds is­sued by the Cal­i­for­nia State Univer­sity Sys­tem as well as the Univer­sity of Cal­i­for­nia, has gen­er­ated to­tal re­turns of 3.6 per­cent this year and 2.2 per­cent in the re­cently ended quar­ter.

Even be­fore in­vestors fac­tor in the tax break ( muni in­come is ex­empt from fed­eral taxes and, in some cases, state taxes as well), that per­for­mance com­pares fa­vor­ably with the 2.3 per­cent re­turns for the Van­guard To­tal Bond Mar­ket ETF this year and the 1.6 per­cent gains in the last quar­ter.

Go­ing for­ward, though, nav­i­gat­ing the muni bond land­scape will get a whole lot trick­ier, money man­agers say.

Even if Trump can­not pro­duce an­nual growth of greater than 3 per­cent, which has eluded the econ­omy lately — or the 4 per­cent rate that the White House promised ear­lier this year — the ad­min­is­tra­tion is still plan­ning to move for­ward on its ef­forts to cut taxes.

Ul­ti­mately, how much in­come tax rates even­tu­ally come down, if at all, will help de­ter­mine the di­rec­tion of muni bond prices.

But the tax cut de­bate it­self is likely to cre­ate short­term volatil­ity for these in­vest­ments.

What’s more, muni in­vestors are largely fol­low­ing a con­ser­va­tive strat­egy.

“You can see where in­vestors are hid­ing out,” says Mark Free­man, co-man­ager of the West­wood In­come Op­por­tu­nity Fund. “Every­body is bunched up at the short end of the curve,” he said, re­fer­ring to muni debt with a ma­tu­rity of no more than five years.

Gregg Fisher, founder of the in­vest­ment man­age­ment firm Ger­stein Fisher, says in­vestors should re­mem­ber a big rea­son for buy­ing muni and other core bonds in the first place: “For the cer­tainty that they present,” he said.

That’s why he sug­gests in­vestors play it rel­a­tively safe for the foun­da­tion of a muni port­fo­lio, by stick­ing with bonds that are from high-qual­ity is­suers with in­vest­ment-grade rat­ings (re­duc­ing the risk of a de­fault) and that ma­ture in less than five years.

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