Fixed-Income Insights
Muni Matters: Four Key Themes for the Decade Ahead
What developments might shape the municipal bond market of the 2020s?
I recently had the opportunity to discuss prospects for economies and markets in the coming year with a number of Lord Abbett colleagues at our 2020 Investment Outlook roundtable. In particular, I enjoyed hearing their questions on the important topics for municipal bonds in the months ahead.
Advisors: Dan Solender and other Lord Abbett experts will tackle prospects for the municipal bond market and other key topics during our 2020 Investment Outlook Webinar on January 8. Register now.
But January 1, 2020, doesn’t just mark the start of a new year. It also heralds a new decade. What might the 2020s bring for municipal bond investors? While we don’t make predictions on asset prices, as long-term investors, we are mindful of future developments that might shape the muni bond market in the coming years. Here’s a brief look at four trends we will be watching as the new decade unfolds:
Retiring Baby Boomers
Baby Boomers will be moving into retirement age en masse in the next several years and that could potentially have an impact on municipals in several ways. First, these newly minted retirees might become more conservative in their asset allocations, showing a greater preference for fixed income. That would be a positive for muni-bond demand.
Second, the healthcare sector—which makes up a large part of the revenue bond segment of the muni market—likely will be affected as more retirees start using Medicare, which provides lower reimbursement rates than commercial insurers. This will mean increased demand for healthcare services, but also greater pressure on margins for hospitals and other healthcare providers, so it could be both a positive and a negative.
Third, many retiring Boomers might try to sell houses as they downsize or move to senior living communities. This could have an impact on housing prices, which in turn could affect collection of real estate taxes by local governments. These shortfalls could put some pressure on local budgets if revenue growth is not strong.
Infrastructure
The United States has a lot of infrastructure needs which get a lot of headlines, but keep being deferred. Eventually these projects, such as the long-discussed train tunnel between New Jersey and New York, will become necessary and not optional, leading to potentially more municipal bond issuance or increased supply.
Climate Change
We believe climate change is likely to influence municipal bond credit quality, and indeed, the impact is only starting to be seen. For example, the recent wildfires in California have dramatically affected the finances of several cities; coastal states and cities will need to prepare more for the impact of natural catastrophes, such as flooding, that may be exacerbated by accelerating climate change. In recent years, the Federal government has supported a lot of the costs related to these disasters, but going forward, the growing expense of these events may need to be taken on more by local governments or independent organizations.
Pension Funding
For the handful of U.S. states that have not sufficiently funded their pensions, and have thus far avoided a significant impact on their overall finances, the clock will be running in the 2020s. These states, including Illinois and New Jersey, will need to be proactive with their annual contributions and investment decisions in order to make sure cash flow issues keep being pushed further into the future. Fortunately, all of them have been making greater efforts in this direction in recent years.
Summing Up
The municipal bond market has benefited from a number of asset-class focused developments over the past several years, including interest-rate moves and tax-policy changes. Going forward, however, the trends we’ve discussed here may also have a significant impact on the market as the new decade progresses.
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. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Lower-rated investments may be subject to greater price volatility than higher-rated investments. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other 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.
The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. 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. Past performance is not a reliable indicator of future results.
This commentary 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.
The information provided is not directed at any investor or category of investors and is provided solely as general 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 the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.