Slowing Economy: 3 Reasons Municipal Bonds Make Sense
July 14, 2023
Read Time 3 MIN
Most investors seek stable and secure investment options in the face of economic decline marked by intense market volatility and wavering consumer confidence. With their strong credit ratings, favorable credit conditions, and historically positive performance during recessions, municipal bonds emerge as an attractive choice. Here are 3 reasons municipal bonds may be a good investment if we face an economic slowdown.
Reason #1: Higher Credit Ratings for Municipal Bonds
Municipal bonds tend to have higher credit ratings compared to corporate bonds. Approximately 70% of bonds in the Bloomberg Municipal Bond Index hold the two highest credit rating categories, contrasting with only 8% in the Bloomberg Corporate Bond Index. Factors contributing to these robust ratings include the absence of competition for many muni issuers, durable revenue sources such as taxes, and the rarity of defaults, even during recessionary periods. In the 2007-2009 financial crisis, only 12 rated muni issuers defaulted, in contrast to 414 corporate bond issuers of similar credit quality.
Reason #2: Improved Municipal Bond Credit Conditions
Most state and local governments have benefited from strong fiscal conditions due to substantial federal government support during the pandemic and surging tax revenues. Rainy-day funds, intended to address unexpected deficits, have reached near-record levels. Even the lowest-rated state in the muni market, Illinois, has significantly increased its rainy-day fund balance, providing added financial stability. Tax revenues typically do not decline until the later stages of a recession, allowing states time to adjust expenses and recover quickly.
Total Balances (in millions of dollars) 50-State Median
Source: The Pew Charitable Trusts. Gray bars represent U.S. recessionary periods. Data is reported by each state for its fiscal year, which ends June 30 in all but four states: New York (March 31), Texas (Aug. 31), and Alabama and Michigan (both Sept. 30). Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
Reason #3: Positive Municipal Bond Historical Performance Post Recession
Investment grade municipal bonds have shown positive total returns in the 12 months following the start of a recession in 5 out of the past five, showing they have been resilient during economic downturns. Only during the 2007-2009 recession, which saw a global credit crisis, did munis post a negative return. Performance during recessions is influenced by various market dynamics, with each downturn having unique characteristics. Historical examples, such as the 1981 recession driven by aggressive interest rate hikes and the 1990 and 2001 recessions characterized by yields moving lower, demonstrate the potential for positive muni returns during economic slowdowns. It is important to consider the current market conditions, as muni yields are presently at their highest levels in over a decade.
Bloomberg Municipal Bond Index 12-Month Total Return
Source: Bloomberg as of July 10, 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
Regardless of the economy's direction, municipal bonds are appealing, given their tax-advantaged income. Investors should focus on highly rated issuers known for their resilience during economic declines, which can provide insulation for their bond portfolios if a recession occurs. While past performance can offer insights, it is crucial to recognize that each recession is distinct and influenced by different factors. However, the combination of strong credit ratings, favorable credit conditions, and historically positive performance make municipal bonds a compelling choice for investors amid a slowing economy.
IMPORTANT DEFINITIONS AND DISCLOSURES
The Bloomberg Municipal Bond Index covers the USD denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-funded bonds. The 7-year Index consists of bonds from the Municipal Bond Index with maturities of approximately 7 years. Bonds in the Long Index mature in 22 years or longer.
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This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
Municipal bonds may be less liquid than taxable bonds. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that municipal bonds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. When interest rates rise, bond prices fall.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.
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