Municipal Credit, Warren Buffett And The Dead Cat Bounce
If March is known for its ides, the municipal bond market has been feeling particularly blown around as this month comes to a close. The yield on the IHS Markit 10-year Municipal AAA curve hit a low of 0.86% on March 16, 2020, the lowest rate posted in literally decades. The yield on the IHS Municipal AAA 30-year curve was in line with that, closing at a record low of 1.47%.
Here Comes the Ides
Bondholders of outstanding debt initially cheered. This nearly unbroken rally started back in November 2018 when the 10-year and 30-year were at 2.78% and 3.42%, respectively. Almost every month saw bond values in funds or portfolios rise higher. Bond prices are the inverse of bond yields: the lower the yield, the higher the price.
The cheering was short lived. Literally the next day, March 17, the municipal bond market saw rates take a vertical climb back-up. The 10-year added back 83 basis points (a basis point is 1/100th of 1.00%) and the 30-year, not to be outdone, added back 87 basis points. It was a reversal more dramatic than during the financial crisis in 2008. By March 25, both curves had added another 19 basis points. In the course of just seven days, the market had given up nearly half of the gains racked-up since 2018. Ouch.
Feeling the Luv
Some investors saw this as a buying opportunity. There was a frenzy of activity over this apparent market dislocation. The buying spree took rates back down, the market closing the week at 1.25% yield on the 10-year and 1.85% on the 30-year.
A host of financial pundits, analysts and strategists expounded on what this all meant. Was it "LUV" and if so, what kind? A plateau (the "L")? Or a turning point (the "U" or the "V")? Or was it just, in Wall Street's often gallows humor inspired, a "Dead Cat Bounce?” I'm more inclined to draw on Warren Buffett's reflections that Mr. Market has "incurable emotional problems." Whatever analogy chosen, this rally did provide some emotional release, a collective "whew" from investors.
The Fundamentals Haven’t Changed
But don't be distracted. A two- or three-day rate rally does not wipe away real, tangible underlying credit issues any more than a back-up in rates provides a buying opportunity. For example, New York City estimates lost revenues due to the coronavirus at more than $15 billion and counting. The recently passed federal CARES legislation will make up for barely 10% of that, percentage declining by the day. Do the math.
Let's face reality. The economic effects of the coronavirus on municipalities and governmental authorities have yet to be fully felt. It hardly goes out on a limb to say these are not going to be positive. Follow-along. There is no sector or debt security that isn’t going to be negatively impacted by this pandemic. Here are just a few to consider.
With "Stay In Place," people aren't shopping, so bonds and budgets supported by sales tax revenues are going to get crushed. No two ways about it.
Now working from home, people aren't driving or taking mass transit. That means bonds backed by toll roads and commuter fees are going to have serious revenue gaps.
For millions of people suddenly now not working, the spike in unemployment hits budgets with large income tax components. Those are going to see large percentage declines.
Capital gains taxes aren’t going to make up for these budget hits. If anything, those revenues are as likely to drop nearly as fast as the stock market’s decline.
Air travel is down and with it airport revenues—both gate fees from airlines and revenues from travelers. Last but hardly least are healthcare systems.
With seemingly exponential health care costs, these front-line responders cannot help but be financially stressed. Some may need direct support.
Investors and their advisers overseeing "mattress money" municipal bond portfolios should be analyzing the credit changes in these holdings to assess, track and measure the outcomes of this difficult economic environment. Forewarned is forearmed.
There is enough real risk currently. It only adds more risk to not do the necessary ongoing analysis. At this time in history, hand washing is encouraged, not hand wringing.
Be safe, stay healthy.