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Market volatility has restored value in the muni market. Now may be a time for clients to begin adding to their municipal holdings
It’s no secret that markets have experienced increased volatility since the beginning of 2022. Geopolitical concerns around the Russia-Ukraine conflict, inflation, and the potential for rising interest rates are all weighing on investors’ minds. As of March 2nd, the S&P 500 is down -7.9%, the Dow Jones is down -6.7%, and oil is up more than 50%. Fixed income has also not been immune to the negative headwinds with the Bloomberg Treasury index down more than -3.00%, the Bloomberg US Aggregate Bond Index down -3.8% and the Bloomberg Corporate Bond Index down -6.1%.
Municipals, sometimes viewed as a sleepy corner of the fixed income market, have also experienced a volatile beginning to the year which has resulted in negative total returns to kick off 2022. Currently, the Bloomberg Municipal Bond Index is down about -3.00% and January was the worst month for municipal performance since March 2020 and February also posting negative returns of -.36%. While it can be tempting to see the negative returns year-to-date and question whether it might be time to sell your municipal holdings or if adding munis to your portfolio now would be a wise choice, it’s worth considering some other points when weighing the decision.
In our view, the recent sell-off has restored value to a market that had gotten expensive. Both 2020 and 2021 were strong performance years for the asset class. Given the tax-exempt nature of municipals, something that we pay attention to is how municipals – a largely very high credit quality asset class- are performing versus US Treasuries and what the yield ratios are. In other words, the higher the muni/treasury ratio, the more value you’re able to realize by owing municipals. To further illustrate the point, on December 31st a 10-year AAA-rated municipal was yielding 69% of the 10-year Treasury Note. As of March 2nd, that ratio had climbed to 83%. On December 31st 30-year AAA-rated munis were yielding 79% of the 30-year Treasury Bond. That ratio jumped to 87% as of March 2nd.1 What this illustrates is that value has been restored to the market given that municipals have gotten less expensive as yields have climbed. These higher ratios are even more impressive when you remember that the interest from municipals is tax-exempt from Federal, State, and local taxes.2
In addition to attractive ratios, municipal bonds also have a long history of outperformance during periods of rising interest rates, particularly important given our expectation that the Fed will begin tightening monetary policy at the upcoming March FOMC meeting.
Total return in rising rate environments
Source: Bloomberg, Bloomberg Indices, BlackRock, as of 3/2/22
During the post-pandemic recovery, 10-year U.S. Treasury yields rose +154bps from early-August 2020 thru mid-February 2022. During that time period, the Bloomberg Municipal Bond Index produced total returns of -0.87%, whereas the Bloomberg U.S. Treasury Index produced total returns of -7.85%. For comparison purposes, the Bloomberg Municipal Bond Index maintained a modified duration of 5.14 years and an average credit of AA2/AA3 as of March 2nd, while the Bloomberg U.S. Treasury Index maintained a modified duration of 6.92 years and an average credit of AA A/AAA. Similarly, from early-July 2016 through early-October 2018, during the most recent Fed hiking cycle, 10-year U.S. Treasury yields increased by +188bps. During that time period, the Bloomberg Municipal Bond Index outperformed the Bloomberg U.S. Treasury Index by +524bps. While it is likely that volatility could continue over the near term, we do think it makes sese for investors to take advantage of this cheapening and slowly begin to add to their municipal holdings. Yields have moved higher, and we believe investors will ultimately be rewarded for their patience, and for using the recent pullback as an opportunity to put some money to work.
1Source: MMD and Bloomberg Indices as of 3/2/22. The 10 year treasury is considered a note, while the 30 year treasury is a bond.
2While all municipal bonds are exempt from federal taxes, only residents of state of issuance will be eligible for state and local tax exemptions.
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© 2023 BlackRock, Inc. All rights reserved.
Investing involves risk, including possible loss of principal.
The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income from tax-exempt bonds may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Past performance is no guarantee of future results
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of March 2, 2022, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader.
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