Market Commentary: Investment Ballpark

The investment ballpark, much like every stadium across the country, looks different at this point in the season. It has changed as a result of the coronavirus and is still morphing as major players study the whole lineup of social unrest, campaign platforms, and this start-and-stop economic recovery with its unprecedented unemployment, school and business closures, and financial pressures that caused nearly one third of all Americans to miss their housing payments due on July 1. In the same way that Major League Baseball has been struggling with health and safety issues affecting players and fans to determine the future of the game amid alarming increases in cases, conventional financial analysts taking in all these unsettling conditions might deem most investments ill-advised at this time, perhaps none more so than the obligations of state and local government whose revenues have plummeted alongside incomes and sales.

There are some 65,000 individual municipal borrowers with about a million different credits outstanding. Many are general obligations of state and local governments stressed by six months of tax streams that have dried up and a gush of unexpected social spending. Some are backed by specific revenues that have been more impacted than others. Common problems for all are compounded for some by issues stemming from trade wars, court decisions, violent crime, and population moves. Many government and nonprofit borrowers began the year with robust rainy day funds — but plenty of others did not and their best laid plans have been scuttled by Covid-19 related shutdowns. Urgent needs and wish lists have been exchanged with Congress, but the terms of a fifth federal aid package have yet to be determined at this writing. In the meantime, in spite of all the facts and headlines, the 11-week rally continues and municipal bonds are advancing steadily once again. Last week, the 10-year tax-exempt AAA general obligation benchmark yields fell another 4 basis points to 0.71% right alongside U.S. Treasuries, which fell like a sinking fastball from 0.63% to 0.59%. The 30-year muni yield also dropped 4 basis points to 1.43% while the long bond boosted its slugging percentage such that its yield fell a full 10 basis points to 1.23%.

Several factors contribute to the string of rising bond prices. First, the Federal Reserve has not only held rates near zero but also positioned itself as the equivalent of a baseball backstop for both municipal and corporate bonds with liquidity programs that have lulled markets into thinking they are protected from wild pitches. Second, whether or not historic data is relevant to the current times, analysts continue to point to an “error rate” for munis that remains extremely low. Moody’s data from 1970 through 2019 shows that the average five-year annual default rate for its rated municipal bonds was 0.08%. Corporate bonds, which have lower ratings, had a 6.7% default rate over the same period. Third, cash that has been sitting on the sidelines continues to pour into the mutual funds and ETFs from households and institutions; Lipper reported $2.1 billion of municipal inflows and $11 billion of taxable bond fund inflows for the week ended July 22. Fourth, many corporations have paused or cut stock dividends, causing some to exit the equity markets and look to the bond markets for less volatile and more reliable sources of income.

A fifth factor, and one of the most significant, involves the supply/demand imbalance. The low rate environment and need to bolster liquidity to survive a pandemic of uncertain length and effect, has caused a record surge in taxable bond issuance. The U.S. Treasury has borrowed more than $3.4 trillion as of June 30 and plans another $677 billion of debt issuance by the end of the third quarter. Corporation have issued more than $1.2 trillion of investment grade debt and $230 billion of below-investment grade debt so far this year. The year-to-date supply of municipal bonds totals $239 billion, up 25% from last year at this time, despite the pullback in issuance during volatile conditions in March. But an increasing percentage of this debt is coming in the form of taxable issues for hospitals, colleges and large borrowers refinancing debt under the 2018 tax law. So far this year there have been about $69 billion of taxable munis issued; this month, taxable munis are expected to exceed 50% of new issuance according to Municipal Market Advisors. This exacerbates the supply/demand imbalance for tax-exempts which are being sought in great part to offset the loss of state and local tax deduction. The loss was felt by millions again on July 15, the tax filing deadline that was extended due to the coronavirus.

Major bondbuyers — life, property and casualty insurers, pension funds, and foreign institutions have become switch hitters — crossing over into the muni space historically dominated by U.S. households. As sovereign and corporate yields have plummeted under fiscal and monetary policy, and negative yielding debt approaches $15 trillion, tax-exempt and taxable U.S. muni yields are waving buyers in like a third base coach. The 30-year A rated taxable muni yield was 2.94% on Monday, versus 2.76% for the comparable A rated corporate maturity and 1.88% for the comparable A rated tax-exempt.

As we approach August 1, the municipal market is expected to see the largest of the year’s major coupon, call, and principal maturities deliver even more cash to an undersupplied market. Investors will not find as much in the way of pinch runners as they would like. Yields are lower across the board. Dealer inventories are at also at historic lows. Many of the bonds in the few bid-wanted “rosters” in circulation have yields so low that they are in fact negative after accounting for fees and inflation.

The new issue market has been the only game in town for buyers of yield. This week’s calendar will likely come in under $7 billion, so there will not be enough to go around. Last week in the high yield sector, we saw five charter schools. Warren Academy of Michigan came to market with a non-rated $9.6 million limited offering structured with a 30-year maturity that priced at a premium 5.50% to yield 5.45%. Landmark Academy in Michigan sold $13.4 million of BB rated bonds that had a maximum yield of 5.00% in 2045. The College Prep Middle School in Spring Valley, California placed $12 million of non-rated bonds at par to yield 5.00%. MAST Community Charter School in Philadelphia had a $27.7 million financing with BBB-minus rated bonds structured with a 2050 term maturity priced with a 5.00% coupon to yield 3.32%. And Renaissance Charter in Florida borrowed $66.1 million in a non-rated financing that included 30 year bonds priced at 5.00% to yield 4.375%. The Sweet Galilee at the Wigwam assisted living community in Anderson, Indiana brought a $22.4 million non-rated transaction priced at par to yield 5.375% in 2040. The White River Health System in Arkansas had $32.6 million BBB-minus rated bonds issued through the City of Batesville that had a final maturity in 2032 priced with a coupon of 3.25% at a discount to yield 3.35%. McLean Affiliates in Simsbury, Connecticut brought a $64.8 million BB+ rated bond financing due in 2026 and priced at par to yield 2.75%. And Navistar International Corporation had a $225 million B3 rated financing priced at par to yield 4.75% in 20 years.

U.S. Corporations are in the process of reporting second quarter earnings which, while devastating, are in many cases slightly better than feared. Through last Friday, more than a quarter of S&P 500 companies have announced results. Losses larger than those taken at the height of the last recession have not, however, steered investors away from the stock or corporate bond markets. The Dow gave up 202 points last week to close at 26,469. The index is down 7.25% on the year but has crawled back from its March low of 18,591. The S&P 500 lost 9 points but has erased nearly all its early season pandemic loss and is nearly flat in 2020. A handful of all-star technology stocks have caused The Nasdaq to outperform; although the index fell 140 points last week, is up 15.5% this year. Oil held steady at $41.29 but is off 32% since January. Gold has rallied to record highs; last week prices per ounce rose $92 or 5% and are currently 28% or $473 higher than where they started the year.

HJ Sims has been working with a number of nonprofit and for-profit borrowers to help them take advantage of current market conditions and opportunities. Our traders and advisors have been proactive in working with our investing clients on portfolio reviews, swaps and recommendations for strategically putting free cash to work. We are closely following some of the trends in credit impairments and encourage careful and regular professional surveillance of holdings to ensure that current risk limits and future income needs are in line. Those taking summer staycations, those with time to spare when MLB games are postponed, and those doing quarterly or mid-year reviews can benefit from a conversation with their HJ Sims