For many, many years muni bonds have been the go-to for tax-free income. While their yields were lower than conventional credits, there was usually a significant cost-savings by investing in the bonds because of the lack of taxation. However, the muni market is so over-bought that it is very difficult to find bonds where that is still the case. Prices have moved yields so low that there are virtually no savings versus Treasuries. 2019 saw muni bonds experience their highest inflows since 2009, and according to Morningstar “For most taxpayers, there’s no longer a significant yield advantage for muni funds after you take taxes into account”.
FINSUM: Weak yields and no savings, which is going to push investors to buy ever riskier munis. Boom time coming for lower-rated credits?
Ban of America says it is a very good time for investors to buy TIPS, or Treasury Inflation-protected securities. The bank thinks inflation expectations are going to rise this year and they are bullish on long-dated TIPS. The call is notable as many fund managers lost money with similar bets after the Crisis, when many thought inflation would jump alongside QE. This time may be different as the Fed has explicitly said it would let inflation run hot to compensate for the slow inflation we have had for the last decade.
FINSUM: We just don’t see inflation rising much in the near term. There are still a lot of worries about the economy. We feel like 2019 would have been the year for big inflation worries/rises, but it didn’t materialize.
There is big risk to the muni bond market that you are probably aren’t thinking about. That risk is how increasingly frequent weather-related calamities are befalling US cities as the climate changes. The market is already starting to price these risks, and according to BlackRock, many current muni bond issuers could see 1% knocked of their economic output. According to the head of muni bonds at BNY Mellon, “The risk has been identified by market participants … Looking at the severity of storms picking up . . . it will start to be factored in”. When choosing bonds, investors need to start demanding or checking on plans from issuers. “What plans are they making? Are they hardening their infrastructure . . . are they trying to insulate central services? If they’re just stating the obvious, that’s not sufficient”, says BNY Mellon.
FINSUM: This is an important consideration for all those that hold munis. Think of the weather-related calamities that have happened lately and consider the implications (e.g. Houston).
For around a year now, the yield curve has been scaring investors. The inversion of the curve sent a grave warning sign to the market that a recession may be on its way. Many investors fled the market for fear of a big reversal. However, as we enter 2020, the yield curve is sending a very different signal—optimism. The curve is at its steepest level since October 2018, showing investors’ increasing confidence in the US economy. One CIO described the situation this way, saying “If the stock market is right that everything is amazing, I don’t see how long rates can stay as low as they are … The stock market is rallying on hope. Hope that things will inflect higher with this trade deal and Fed accommodation”.
FINSUM: If there is one thing we have learned in the last decade, it is that the Fed does not want to over-hike on rates. Overall, we think this is a very healthy direction for yields.
It has taken a long time for bond ETFs to begin getting even a tiny bit of the attention stock ETFs have gotten, but the trend has finally taken hold in earnest, and that s good news for investors. While active bond funds have done well in recent years (perhaps due to it being considered easier to outperform a bond index than a stock index), bond ETFs have now started to surpass them in growth. This is adding much more liquidity to bond funds, which benefits investors substantially. Both active and passive bond funds have taken in over $200 bn each in 2019.
FINSUM: While “liquidity mismatch” worries will continue to linger, the fact is that bond ETFs make a lot of sense (perhaps even more than stock ETFs?) because they circumvent minimum-buy and illiquidity issues, allowing many more people to access hard-to-reach corners of the bond market.