Last Week’s Markets in Review: Municipal Bonds in a Rising Rate Environment
Global equity markets finished lower for the week. In the U.S., the S&P 500 Index closed the week at a level of 3,912, representing a gain of 6.70%, while the Russell Midcap Index moved 5.04% higher last week. Meanwhile, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, returned 7.04% over the week. As developed international equity performance and emerging markets were also higher, returning 2.83% and 0.78%, respectively. Finally, the 10-year U.S. Treasury yield moved lower, closing the week at 3.13%.
Municipal bond prices and yields are largely affected by the supply and demand of these bonds in the open market. As investors seek safety or income in their portfolios, the demand increases, pushing the prices of bonds higher. At the same time, when investors are concerned about rates rising and the opportunity cost of missing out on higher yields, the demand falls along with prices, pushing yields higher. While the latter has been the case so far in 2022, we believe a significant change in the supply and demand dynamic of the municipal bond market is likely this summer. According to Bloomberg, $123 Billion of municipal bond debt is expected to mature during June, July, and August. At the same time, as of the time of this writing, the 30-day visible supply of municipal bonds is just $13.6 billion. As these bonds come due in the coming months, a large demand will be created as institutional and retail investors seek reinvestment options within limited supply availability.
Past performance is not indicative of future results, but it can help give us a rough understanding of what might be expected ahead. As such, the first quarter of 2022 was the worst quarter for municipal bonds in over 40 years, resulting in a loss of 6.4% as investors reacted to the Federal Reserve’s aggressive rate hike policy. Since 2000, however, the Barclays Municipal Bond Index has only experienced losses of 5% or more in seven instances. According to New York Life Investments, these drawdown periods proved to be among the strongest buying opportunities for municipal bonds over the past 20+ years. In fact, municipal bonds experienced double-digit returns during the subsequent 12 months following the bottom of these drawdown periods in four of the prior six instances, with an average return of 12%.
During a rising interest rate environment, investors of municipal bonds can often achieve outperformance compared to their government-backed bonds brethren. According to research from LPL, municipal bond markets have tended to outperform U.S. Treasuries (measured by the Bloomberg Treasury Index) during rising-rate environments. Consider that since 2004, investment-grade municipal bonds had outperformed U.S. Treasuries in 12 of the last 13 times that the 10-year treasury yield moved meaningfully higher, as measured by the Bloomberg Municipal Bond Index.
In our view, the fundamentals for municipalities remain relatively strong, and current valuations make municipal bonds worthy of consideration on a forward-looking basis, particularly for high-net-worth investors looking for sources of tax-free income.
Investors should consider all the information discussed within this market update and many other factors. We believe it prudent for individual investors to use this time as an opportunity to discuss their investment strategies with experienced financial professionals to help build and manage the asset allocations within their portfolios consistent with their objectives, timeframe, and tolerance for risk.
Best wishes for the week ahead!
Municipal Bond supply data was sourced from Bloomberg on 6/24/22. Equity Market and Fixed Income returns are from JP Morgan as of 6/24/22. Rates and Economic Calendar Data from Bloomberg as of 6/24/22. International developed markets are measured by the MSCI EAFE Index, emerging markets are measured by the MSCI EM Index, and U.S. Large Caps are defined by the S&P 500 Index. Sector performance is measured using the GICS methodology.
Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against a loss.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.