January 1, 2017
Letter from the Chairman…
We were stuck in the horse latitudes for so long that the storm that hit municipal bonds in the fourth quarter was quite a shock. It wasn’t until early December that the muni market found a bid and stabilized. Most municipal portfolios should show a healthy end-of-year recovery in market values over their November 30th reports.
This perfect storm combined worry about the Fed raising rates, President-elect Trump’s agenda, and a near record supply of new bonds as issuers scrambled to get their deals in before the year’s end. All this created fear, irrational selling, and tons of opportunity for those with the discernment to recognize a very oversold market. At the market’s bottom, with so few bidders, bonds could be acquired 120 basis points cheaper than where they traded just a few months prior.
Dismissing the significance of the changes the President-elect has foreshadowed, many of which could negatively impact the municipal market, would be a grave mistake. What’s unclear, however, is when and the extent to which their impact will be felt.
We conclude with good reason that the Fed’s rate hikes will be modest and slow in coming. Any adverse economic data will surely halt them in their tracks. Much of the Trump campaign rhetoric has moderated post-election. He faces very strong headwinds from the fiscal conservatives in his own party in the House of Representatives (including the Speaker of the House) where spending bills originate. History has demonstrated that lowering the top income tax rate does not diminish the appetite for munis. Changing the tax code will take a long, long time to pass and go into effect. The envisioned infrastructure legislation even longer.
The perception that a Trump administration will invigorate economic growth has moved the stock market to new highs. Sustaining this optimism through 2017 will require evidence of accelerated economic growth and that’s where the problem lies. Uncertainty leads to doubt and there is an abundance of uncertainty. Tariffs and trade wars, for example, appear real possibilities and would hurt all involved. A resurgent dollar hurts exporting companies. The problem with job repatriation is that for every ten jobs that were shipped overseas, only one comes back, while nine are lost to automation. Those who think anti-establishment sentiment is limited to Brexit and the United States should think again. Protectionist sentiment grows. Global growth is stagnating and world leaders worry about President-elect Trump’s “drain the swamp” posturing infecting the established international order. His unpredictable temperament concerns many.
So what should municipal bond investors do? Time and again those who acted when the pendulum swung too far have been rewarded. Raise your average weighted cost yield when opportunity allows, keeping inside your risk tolerances with regard to credit strength and maturities. Be sure to calculate the length of time it will take the yield advantage of newly acquired bonds to make up any loss incurred in selling your lower cost yield positions. Remember, there remains a huge amount of liquidity on the sidelines. If the market perceives that our economy is faltering, interest rates could once again plunge. What a shame it would be if you just rode out the storm, safe in the harbor.
The contents herein are for informational purposes only, and under no circumstances are they to be construed as a recommendation of a solicitation. The information and opinions herein are subject to change without notice and CFI does not undertake to advise the reader of changes in opinion or information.
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ADV Part 2 A