Sequestration and The Great Rotation: The Impact on Munis
- Wednesday, 03/20/2013
Watch my latest video which focuses on:
- Near-Term Outlook and Performance Drivers
- Impact of Sequestration on the Market
- Considerations in Light of the Great Rotation
Near-Term Outlook and Performance Drivers
While inflows have been positive, cash for reinvestment, a huge contributor to demand in 2012, has ebbed significantly this March, and is expected to do so again in April. I expect demand will not drive the market forward these next two months as it did most of last year. Looking back at historical returns, since 1990, there have been only five times when March performance has been positive. Large issuance of new bonds, such as the current $2.1 billion California general obligation (GO) issue, is an example of how supply now, and in prior years, has subdued demand. Therefore, my expectations are for munis to underperform slightly these next two months, but create attractive price points for investors come May.
Impact of Sequestration on the Market
Since December and the fiscal cliff issue, the municipal marketplace has responded very positively — at least for the first two months — to congressional pronouncements concerning the long-term viability of the tax-exempt coupon. Going forward, however, uncertainty remains as to whether or not Congress will continue to think about, if not impose, limitations on the tax-exempt coupon. One positive note out of these recent events is the fact that the highest personal income tax rate has gone up to 39.6%. This continues to bode well for munis in an absolute sense, because the value of the tax-exempt coupon to those in the highest tax bracket remains significant.
Considerations in Light of the Great Rotation
Despite the terrific performance that the equity markets have put in year-to-date, there are still opportunities to be had for municipal investors. There are two things to be mindful of. First, the Federal Reserve has given no indication yet that rates are about to rise, or about to rise anytime in the near future. So opportunities to earn taxable-equivalent returns from municipal products still look attractive. Second, the municipal yield curve remains steeply-sloped, particularly in the intermediate part of the curve. That's where many professionals suggest that there are, and will remain, opportunities for investors to earn performance returns for the 2013 calendar year.