February 28, 2022
Market Snapshot: What Muni Underperformance means for investors?
Muni Underperformance Could Signal A Good Entry Point for Investors
- Fixed income markets are off to a volatile start this year as yields continue to price in more aggressive Federal Reserve actions relative to the previous few years of incredibly accommodative policies. It is now a question of when the Fed will start raising rates and by how much (25 or 50 basis points), with the likely kick-off being the March Federal Open Market Committee meeting. The aggressive repricing of expected Fed actions has been the main driver for the recent volatility in bonds. Fed policy is likely to remain front and center this year as the market grapples with rate hikes and eventually balance sheet reduction.
- For municipal bonds specifically, January’s return was in excess of -2%, which has only happened in the benchmark Bloomberg Municipal 1-10 Year Blend Index 8 times since 1993. Although the underperformance was largely a result of the muni market catching up to the move higher in taxable yields, it was notable because January has historically been a strong month for munis, driven by seasonal reinvestment of cash. While past performance does not guarantee future results, in the chart below we see a well-established pattern of strong performance after such a downdraft, which is not surprising given the lower liquidity profile of munis and the tendency of this asset class to overcorrect in both rallies and selloffs. Of the 8 periods highlighted in the chart, only 2 periods (February 1994 and March 1994) were part of a Fed rate hike cycle.
- Also supportive of forward-looking performance is the fact that muni credit in general remains on solid footing, as pandemic-driven revenue shortfalls were not as bad as initially expected and stimulus cash was well in excess of what most municipalities actually needed. Given the market’s tendency to overcorrect, improved yield levels and relative valuation to other fixed income alternatives, we believe an allocation to munis offers an attractive risk/reward at current levels particularly relative to the past few months, and notably for investors with a strategic longer-term allocation to this asset class.
The views expressed represent the opinions of certain GIM portfolio managers as of February 28, 2022, and are not intended as a recommendation of any security, sector or product, and any security identified herein may or may not have been bought, held and/or sold by GIM-managed portfolios. Any opinions or projections herein are based on information available at the time of publication and may change thereafter. Information obtained from third-party sources is assumed to be reliable, but accuracy is not guaranteed. Future developments (including performance) may differ materially from expectations and projections noted herein due to various risks and uncertainties and changes in underlying assumptions. For institutional and professional investors only; not for retail clients.