Municipals in a New Era: Capturing Tax-Exempt Yields

welcome everyone I'm Jen Rogers thanks so much for watching today we're talking about municipal bonds and if now is the time for investors to consider adding them to their portfolio joining us here today are nen's head of municipals Dan close and nen's chief investment officer Sarah Malik thank you both so much for being here and we are going to be diving into munis but Sarah I got to just start at 30,000 fet and help us with where we are right now now you know what fa should be thinking about for the economy and the markets for the balance of 2024 sure thanks for having me you know what we're thinking about is three things the economy fed and inflation so first just starting with the economy which has been strong this year and last year where is it going from here we have started to see some mixed manufacturing data employment markets even are showing some signs of moderating but the good news is the US economy remains strong and that's a positive across the board four states and the federal government let's move on to the FED what are they doing we came into this year expecting up to seven rate cuts and those rate Cuts have slowly been getting priced out of the market where will we go from here our view has always been no more than three rate Cuts this year uh I think I would even take the under on that at this point I think the reason we're going to have less rate Cuts than we originally hoped for at the beginning of this year is because of that sticky inflation it at late in 2023 inflation had started to moderate uh somewhat quickly coming into 2024 inflation started to re accelerate that was because people uh kept spending on services and experiences and even that Goods inflation That was supposed to unwind after the pandemic when Supply chains opened up that moderation even started to slow so it's those three things that we're worried about going forward as for the equity markets they've had a nice rally year year to date I think it's you know what what is going to be our next Catalyst from here I'd like to see inflation start to moderate at a faster rate and maybe some of these Fed rate to get priced back into the markets so Dan Sarah really set this out nicely for us in terms of what we're looking at but what does it mean for the work that you do and particularly for munis because do they work in any environment how do you take what you just said and apply it to people trying to make decisions on when to get in yeah and and thank you so much Jen for uh hosting today I mean we we're seeing some very similar Dynamics in the municipal Market as to what Sarah mentioned and also some very unique characteristics on the mun Market you know first and and on on a similar path investors are really being paid to wait uh there's income for the first time infixed income uh tax exemp exempt income is very attractive when you compare it to just about anything else in the fixed income Marketplace you know if you consider a high quality doublea minus Municipal portfolio in the intermediate part of the curve you know it's yielding right now more than 6% um nen's mun interval fund NM SSX has more than 10% yield on a taxable equivalent basis so you know I I take a look at the entire tax exent mun yield curve um it's yielding more than inflation right now and this is the highest real levels of yield we've had in more than 10 years uh but I guess more unique to the municipal Market is just how good credit quality is right now this is the best credit quality we've seen in more than 40 years agencies recognize this with their 4:1 upgrade ratio uh over the last 3 years we're seeing collections 25% higher than previous uh Peaks at in in 2020 and we're also seeing a record amount of state and local governments having rainy day funds um I think also unique to municipes and how we apply it is really the technical side um consider that for this year and it's going to be the third year uh in a row that we're going to have more bonds called more bonds matured more bonds sync than new issue paper and and what that means for municipes is it's very scarce to have municipes uh the municipal Market has grown less than 5% uh since 2009 uh compared to more than 250% for the treasury market so how we're applying it in our marketpl right now is uh really asking investors to be patient to know that they're getting very high levels of income and we actually have income in fixed income uh for the first time in a very long time um I mean it is really interesting interesting when you look at that landscape I mean Sarah you set out that the FED is really one piece of the puzzle you had three points and I want to dive in a little bit more on the fed and forecasting rates because as you're you're hunting for yield it's an incredibly important part of the fixed income puzzle so um what are just the the key points in there to be really paying attention to I mean as you said um you're taking the under right now on uh how many uh r rate we're looking at sure well the fed's been very clear they do not want to start cutting rates until inflation hits their target which is 2% and we are not near that yet we are running at inflation still about three plus percent levels so first of all I'm concerned inflation may not hit 2% in 2024 it may take till 2025 what is the Fed watching in order to determine when inflation may become less sticky well first is wage inflation and we've seen employment numbers remain very strong Services spending Services inflation has also continued those are areas that need to moderate somewhat the FED also wants to see broader disinflation so not just some of this unwind I talked about good spending has unwind a bit but not unwind as much as we'd like but fed wants to see broader disinflation across the board otherwise the FED risk is risks losing credibility because they'll they could cut rates too soon and the economy could then heat up again and inflation could become even more of a problem and that would be an issue for the Fed so that's what I think they're watching uh in an election year the FED tends to do less rather than more which is another reason that I think as this year goes on the FED is less likely to start aggressively cutting rates and that's why we've been in the three rate Cuts or below camp for this year consistently Dan I mean I I guess I'm so used to rates here and used to hikes I forgot like we're waiting we're waiting for cuts right everyone is waiting what happens though if the FED does nothing like where do you look for y does that change um what you are expecting I mean what does it mean for munis yeah and certainly our our base case is uh you know what Sarah had had articulated that um you know the FED is going to be patient they're going to wait for data to come their way uh and for a municipal investor um you know just again highlighting the the income that is available so even if the FED does nothing we anticipate that M investors are going to have a very very good year you know consider for the first quarter we had 10year treasuries back up uh basis points or so and municipals were able to post you know relatively flat return so I I I think if we see nothing from the FED we could still have a great total return profile for investors and if we do get even one perhaps two rate Cuts uh for 2024 if inflation comes in softer if employment rolls over uh we do have that potential for capital appreciation and then all of the sudden you go from earning that 6% tax equivalent uh income to something that that might be considerably higher and we got a very very small whiff of that in the fourth quarter uh you know with the uh with with November December being up more than 8% for our Marketplace so it's it's super content right now to just have the income component but if there is some capital appreciation and the FED does go down a different path uh we certainly think that would be beneficial for munis sah you make a really interesting point it is an election year unless you've been living under a rock everyone knows that uh the FED as you said tends not to do that much but what about what does it mean for the economy and for the market overall as well what should investors be thinking about sure well the good news on an election year is it tends to be positive for the markets markets tend to go up about 10 11% in an election year so that's the great news now this election year is special we have a lot of countries going to the poll 77 countries and 60% of GDP is going to the polls this year we also have some nuances to the election that we may not have seen in the past misinformation the impact of artificial intelligence that could increase noise around the election years which tend to be more volatile I mentioned the FED tends to do less rather than more during an election year so that's why when I look at Cuts I think of you know summer to fall maybe you see one cut and if you don't see it by then you may have to wait till December to get 25 or 50 basis points uh of rate reductions by the FED because I think they'll hold right around the election uh you know areas that are important during election years Healthcare tends to lag because of regulations uh infrastructure could be a hot issue this year as we bring more of our man manufacturing home and we practice more near Shoring international issues are going to be important and then let's not forget that high level of US debt and what that means as rates stay high I think that's going to be a continued issue around the election and after so Dan last question for you also on the election because for mun you know taxes are so important right like that that is a key to figuring out uh how good they are for you so what about any looming tax tax rate changes like how should financial advisers approach thinking about that yeah I I guess two broad points on on taxes and the election um the first is you know no matter who wins if we have mixed government a red wave a Blue Wave we're still going to see very very broad support for municipals uh you know consider during covid five rounds of Co Finance every single time there was a round of Co Finance it touched state and local governments and this is why you have record balance sheets record r day funds for state and local government so uh regardless of the outcome we think there's going to be very broad local support for municipals um and and we think that's going to be a very positive outcome I I think the one thing that we're looking at right now the closest is the tax cut and jobs act and that's supposed to sunset in 2025 I don't think I'm going out too much on a limb to say that we'll probably have some form of divided government and if the tax coton jobs Act is not um uh extended if the tax code is not gone and in some way changed you're going to automatically have the highest tax bracket going from 37 to 39.6% so under the scenario I I think the likely scenario that we do have divided government I think there's less of a chance to get a comprehensive change to the tax code and automatically you do have an increase in taxes and that just makes the mmunity exemption that much more worthwhile that makes the immunity exemption worth more because you're able to Shield more of your income from taxes so I I think in this election uh no matter how it does turn uh it should be somewhat favorable for municipals because we do view uh the prospect of higher taxes uh to be very high and with higher taxes we usually see a greater value of the tax exemption which should be beneficial for the municipal Market um that's all the time we have really fascinating stuff thank you so much thanks to nven and Dan and Sarah and to everyone watching thank you thank you

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Length: 11min 42sec (702 seconds)

Published: Wed May 22 2024