Joseph G. Mowrer III, BridgeTower Media Newswires
The past 20 years has brought many significant events to the financial markets. There have been four presidents, the attack of 9/11, the financial crisis of 2008, and multiple changes to the tax code, among many others. While the world is a much different place now than it was 20 years ago, there is one investment that remains largely the same. The overall municipal bond market has continued to provide investors with consistent tax-free income with minimal credit/default risk over the years.
One comparison between 1999 and now is the ratio of municipal bond income to comparable Treasury bond income. At the end of 2019, this ratio for a 10-year maturity municipal bond versus a Treasury bond was roughly the same that it was 20 years earlier, 77% at end of 2019 and 79% at end of 1999. In other words, despite several changes to the tax code over the years, we believe investors today place nearly the same value on the tax-exemption of municipal bonds as they did 20 years ago.
This ratio may also indicate that muni bonds now carry the same very low credit/default outlook risk as they have over time. According to the Moody's US Municipal Bond Default and Recovery report, municipal bond defaults have consistently been rare, even during the height of the financial crisis. While there have been areas of stress for some issuers, most recently Puerto Rico, default risk remains rare relative to vast size of the market. Moody's reports an insignificant 0.27% cumulative 20-year default rate for its rated bonds from 1970-2018.
Over the past 20 years municipal bonds have also demonstrated resilience in nearly any market environment; there have been only two years that the Barclays Municipal Bond Index experienced negative returns (2008 and 2013; down roughly 2.5% in each of these years.) The average annualized return over this time period for this index is 5%. As a comparison, a 10-year Treasury bond (considered risk free from a credit perspective) experienced far more volatility and had losses of 10% in 2009 and 8% in 2013.
We expect the municipal bond market to continue along its path of preservation of capital. There have been ongoing improvements to the balance sheets of municipal bond issuers over the years as individual states have seen a rise in revenue along with a decrease in the amount of debt outstanding. Moody's recently concluded that nearly all states (with the exception of Illinois and New Jersey), are now stronger than they were when the recovery began in 2009. And contrary to the federal government that continues to increase its debt load, the municipal bond market has been reducing new issuance, and thus overall debt outstanding has decreased recently.
With these positive dynamics - improved balance sheets, low new supply, and high investor demand - municipal bonds have a strong likelihood to continue their track record of stability. While there's no telling which way interest rates will move next, in our opinion these strong dynamics should help minimize volatility relative to other fixed income investments. A professional manager or a mutual fund may be the best way to maximize returns with the least amount of risk through finding undervalued bonds while paying careful attention to duration and credit risk. We also believe there is opportunity to buy high quality municipal bonds through a closed-end fund at deep discounts, but that is a story for another time.
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Joseph G. Mowrer III is a Senior Tax-Sensitive Fixed Income Analyst for Karpus Investment Management, a local independent, registered investment adviser managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534 (585) 586-4680.
Published: Mon, Jan 27, 2020
