FMNY - The View From Muniland: As The Economy Turns
2023-04-21 02:55:00 ET
Summary
- It was clearly a volatile quarter, but you wouldn’t know that from the end-of-quarter return. The broad muni index was up about 2.8%, but how we got there was a roller-coaster ride.
- But within volatility, there’s always opportunities if you’re looking in the right spot, and clearly if you have the mandate in your portfolios.
- Now within the muni market, we think that there’s a fair amount of opportunity left, even though we’ve seen a bit of a rally in the first quarter.
By Daryl Clements and Jason Mertz
Transcript
Jason Mertz: Daryl, one of the consistent themes that we saw in all of 2022 was market volatility. That was certainly still a prevalent factor in the first quarter of this year so far.
Daryl Clements: It was clearly a volatile quarter, but you wouldn’t know that from the end-of-quarter return. The broad muni index was up about 2.8%, but how we got there was a roller-coaster ride. January up 2.8, roughly, the index was; February down about two and a quarter; March up about two and a quarter. So clearly a volatile quarter throughout.
But within volatility, there’s always opportunities if you’re looking in the right spot , and clearly if you have the mandate in your portfolios. So, for example, investors, if they had the ability to, could have rotated into US Treasuries toward the end of January into early February as municipals were becoming expensive. And what that trade would’ve done, not only would it have helped performance, but probably more importantly for a core muni bond portfolio, would’ve been to reduce volatility.
So for investors who have that mandate or they have flexibility in that mandate, they should always be open to those opportunities.
JM: Kind of looking forward from here, when you think about the Fed and all the volatility we’re seeing around the economy and the banking crisis, etc., what are our expectations for economic growth and the Fed’s reaction to that?
DC: No one can predict the absolute level of yields accurately or effectively over time. But our expectation would be the Fed has one more move in it in the May, the May 3rd meeting, but by, let’s say 12 months out, yields lower, likely. Simply because the economy will likely slow, the Fed will need to react to that by pushing rates down to some level. So I think we can expect, 12 months out, yields to likely be lower then than where they are now, and that’s good for bonds overall.
JM: Generally yields going lower are good for bonds, as you mentioned. Now within the muni market, we think that there’s a fair amount of opportunity left, even though we’ve seen a bit of a rally in the first quarter. From a portfolio positioning standpoint, what are we educating investors on of how to best structure strategies in today’s environment?
DC: Duration is the most important metric in a bond portfolio. And today for a core portfolio, you want to be in an intermediate, let’s say five to seven years. Within that, though, there’s a maturity structure. How are you building to get to that duration target? And the municipal yield curve is wonky today. It’s inverted, and the municipal yield curve has never been inverted for any material amount of time. But today it is. And that inversion is in that 2- to 11-year spot.
So what you want to do is try to, I would argue or say, put it this way, barbell around it, where you want to avoid that belly of the curve where it’s inverted. So you want to be a barbell, you want to have short bonds and some longer bonds.
And then there’s credit: single-A-rated bonds, triple-B-rated bonds, high-yield bonds. In this environment, we would expect that credit outperforms. So in some form or fashion you want to weave in duration into a portfolio, and credit; and to whatever your risk tolerance will take you, wherever it takes you, you want to build that appropriately.
JM: Daryl, diving a little bit deeper into that credit bullet point around the expectation that growth’s going to slow, particularly in that triple-B and below space: How do you think investors should be positioning within that area of the market specifically?
DC: How we think about it is: What’s defensive? What sectors would be defensive in a down economic environment? And they would likely be charter schools, affordable housing; toll roads would be another one. But then there are sectors that are more procyclical or pro-growth, if you will, that you may want to be careful around. And those would be land deals; senior living facilities is another. You want to really, in this environment, utilize credit research. Going it alone would be really, really difficult and concerning. So you really want credit research to come to the fore in this environment.
JM: So you mentioned a couple things that obviously paint a pretty positive outlook for the municipal markets. What do we think investors are waiting for at this point?
DC: I don’t know. We have relatively high yield. Yields haven’t been this high in the last decade or so. We have credit spreads that are nearly twice their historical average; at least triple-B credit spreads are. You have the Fed that is likely in the eighth or ninth inning of their interest rate cycle. Supply is down over 20%; demand is picking back up. So it’s hard to really understand what investors are waiting for, but the opportunity is fairly substantial going forward.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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The View From Muniland: As The Economy Turns