2021 Investment Outlook: Municipal Bonds | Lord Abbett
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Fixed-Income Insights

Lord Abbett’s Director of Municipal Bonds talks about the challenges that muni issuers faced during the pandemic, and the prospects for the municipal market as we move forward to a recovery in 2021.

Read time: 3 minutes

Two Sides to the Municipal Market

Municipal credits have held up well and maintained their historically strong quality during the COVID-19 crisis. On a credit-impact basis, two primary contributors supported fundamentals during this period.  First, reported tax revenues did not fall as much as the market anticipated. State and local government issuers responded quickly to the crisis with cost-cutting initiatives in order to maintain budgets. Similar reactions were seen across multiple municipal sectors, largely sustaining credit fundamentals in the wake of declining revenue. Second, the CARES Act provided support across a broad range of municipal issuers, including hospitals, senior living facilities, and airports, for example. The combination of CARES Act support and crisis-induced reactions to address costs helped to alleviate credit impacts, evidenced in the much lower-than-expected number of credit-rating downgrades reported during the past year (see Figure 1).

 

Figure 1. 2020 S&P Municipal Credit Rating and Outlook Changes

S&P ratings actions across approximately $2.7 trillion in municipal credit securities

Source: S&P Global Ratings. Data as of 9/30/20. S&P Global Ratings is a U.S.-based credit rating agency and a division of S&P Global that publishes financial research and analysis on stocks, bonds, and commodities.

 

The municipal market is also driven by sentiment, a substantial portion coming from retail investors who own approximately 70% of municipal issues. Sentiment has consistently improved since the early stages of the pandemic and strengthened further with the announced COVID-19 vaccines, allowing for a broadening in ownership, to a degree, across issuers and credit quality. Although the lower-quality segment of the market lagged investment-grade sectors for most of the year, the combination of fundamental credit support and constructive sentiment brought together both sides of the municipal market toward the end of the year. We saw the seventh straight year of positive performance with the Bloomberg Barclays Municipal Bond Index posting a return of 5.2% for 2020. The high-yield segment, represented by the Bloomberg Barclays High Yield Municipal Bond Index, returned 4.9%.

Pre-Recovery Phase

Moving forward into 2021, municipal issuers will need to continue to respond to current challenges, pending a full recovery provided by the vaccines. State and local governments have already taken steps to address budget constraints while revenues come under pressure, although less than expected, and we have seen similar responses from a broad range of sectors in the municipal market. After a rough spring, hospitals were able to add back high-margin procedures, such as elective surgeries. Airports and universities continue to realign processes to maintain operations and have also taken steps to adjust budgets. Overall, the municipal market has shown resilience, which we believe bodes well for the sector, as we progress toward the recovery phase of the pandemic.

Post-Pandemic Period

Looking further into 2021, potential areas of opportunity, in our view, could come out of the lower-quality segment of the market where spreads have widened, and performance is still lagging the higher-quality portions of the market. Relatively attractive tax-equivalent yields, based on the steeper yield curve of lower-quality municipal bonds, could also provide return opportunity to a broader base of investors (see Figure 2). 

 

Figure 2. Yields on Lower-Quality Muni Bonds Could Provide Attractive Opportunity in 2021

U.S. Treasury yield curve versus municipal bond yield curves by quality segment, December 30, 2020.

Source: Bloomberg. Data as of 12/30/20. A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The municipal bond curves displayed in this chart represent ratings-specific segments of the Bloomberg Barclays Municipal Bond Index.

 

A continuation of current U.S. Federal Reserve policy of low short-term interest rates potentially provides relative support to all maturities but especially intermediate-term municipals on a risk-return basis. During 2020, with uncertainty still weighing on the municipal market, demand had been primarily strongest within the five-year maturity range. As the outlook has turned more positive with the vaccines, risk taking has increased, which is already benefiting intermediate - and long-term maturity segments of the market, and is likely to continue to do so going forward, as short rates have moved very low. 

The Move to Blue

Additional positive implications for the municipal bond market recently surfaced with the election results that unfolded in early January. A Democratic majority in Congress raises the prospect of additional aid to state and local governments, providing further support for those credits. In our view, the election outcome also increases the probability of higher corporate tax rates down the road, following the recovery period in 2021. Higher corporate taxes could entice previous market participants that were buyers of tax-exempt municipals historically, such as banks and insurance companies, back into the market.

Importantly, issuance in the tax-exempt space has been just average. However, taxable municipal bond

issuance grew dramatically during 2020. Supply-and-demand dynamics could prove beneficial with income tax rates still providing attractive tax-equivalent yields and tax-exempt supply not picking up much, as the lower rates continue to make taxable municipal bond rates attractive to issuers. After the economic recovery is firmly in place, the move to blue in Washington creates a more feasible environment in which the new administration could implement changes to personal income tax rates, making tax-exempt municipal bonds more attractive to certain individuals. Overall, our outlook for the municipal bond sector is positive given these factors.

 

IMPORTANT INFORMATION

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

Bloomberg Barclays Municipal Bond Index: a rules-based, market-value-weighted index engineered for the long-term, tax-exempt bond market.  Bonds must be rated investment-grade (Baa3/BBB- or higher) by at least two ratings agencies.  They must have an outstanding par value of at least $7 million and be issued as part of a transaction of at least $75 million. The bonds must be fixed rate, have a dated-date after December 31, 1990, and must be at least one year from their maturity date.

Bloomberg Barclays High Yield Municipal Bond Index is an unmanaged index consisting of non-investment-grade, unrated or below Ba1 bonds.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The credit quality of the securities in a portfolio are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from 'AAA' (highest) to 'D' (lowest). Bonds rated 'BBB' or above are considered investment grade. Credit ratings 'BB' and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

No investing strategy can overcome all market volatility or guarantee future results. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

The information provided is not directed at any investor or category of investors and is provided solely as general SOCIAL MEDIA information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action, as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this article are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

FIXED-INCOME INSIGHTS PDF

 

    2021 Investment Outlook: Municipal Bonds

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