Munis have had a strong showing year-to-date and continue to represent an essential tool for potentially generating tax-advantaged income within a diversified investment portfolio. Moreover, the upcoming election and expected Federal Reserve rate cuts may offer additional opportunities for this unique asset class to flourish.

In the third quarter of 2024, US Corporate returned 5.87%, US Aggregate 5.196%, corporate high yield returned 5.28%, and US Treasuries returned 4.74%, respectively.^1,2,3,4 In the muni market, returns in investment-grade tax-exempt and taxable returned were 2.71% and 5.42%, respectively, with high yield municipal returning 3.21% .^5,6,7 Furthermore, the muni market continues to perform well despite issuance being up 46% year over year as of the end of September, thanks to the return of mutual fund inflows.⁸ As of the end of September, year-to-date flows were up $25.2 billion, split roughly evenly between the investment grade and high yield municipal markets.⁸

We explore three key aspects of the municipal bond market that investors should consider: the potential impact of the upcoming election on issuance patterns, specific muni strategies that may fit various investment portfolios, and lastly, the current trends in the muni market, including sectors to watch.

Election impact

As we approach the upcoming election, muni investors should be prepared for potential short-term fluctuations in issuance patterns. Elections can significantly influence the muni market due to their impact on local and state government policies, budgets, and infrastructure projects.

Pre-election surge

We often observe a surge in muni issuance in the months leading up to an election. Local governments and municipalities may rush to issue bonds before potential administration or policy direction changes. This pre-election surge can create opportunities for investors, as the increased supply may create an attractive entry point for market participants. Yields may remain relatively elevated during this period, allowing a window of opportunity to invest and realize the benefit of the tax exemption on a higher income threshold.

Post-election uncertainty

Conversely, the period immediately following an election can be marked by uncertainty. New administrations may review and reassess ongoing projects, potentially leading to delays or cancellations of planned bond issuances. This uncertainty can result in a temporary slowdown in new bond offerings.

Policy shifts and long-term implications

The election's outcome is expected to lead to significant policy shifts that affect the muni market over the longer term. For example:

We believe investors must stay informed about the political landscape and be prepared to adjust their strategies accordingly. While short-term fluctuations may present challenges and opportunities, the fundamental benefits of munis – namely, tax-advantaged income – remain intact regardless of election outcomes.

Strategies and portfolio fit

Amid political uncertainty and marketing volatility, we believe two muni strategies – ultrashort and short-duration high yield – offer unique risk-return profiles and potential roles within a diversified portfolio.

Ultrashort

Ultrashort municipal bonds typically have less than one year of maturities, which offers several advantages. These bonds have lower interest rate sensitivity due to their short duration, making them less vulnerable to interest rate fluctuations. They also offer high liquidity, as they can be easily converted to cash, making them suitable for investors who may need quick access to their funds.

Additionally, ultrashort munis generally provide more stable returns compared to longer-duration bonds. They can serve as a cash management tool or as a conservative component of a fixed income portfolio, particularly for investors seeking to minimize interest rate risk while benefiting from tax-exempt income.

Short-duration high yield

Short-duration high yield municipal bonds offer a compromise between the safety of investment-grade bonds and the higher yields of longer-duration high yield bonds.

These bonds typically provide higher yields than investment-grade munis while also helping to mitigate some interest rate risk due to their shorter duration. However, investors should be aware of the increased credit risk associated with these bonds compared to investment-grade munis.

Despite this risk, short-duration high yield munis can be an attractive option for investors looking to boost their portfolio yield while managing interest rate risk, especially for those willing to accept moderate credit risk in exchange for potentially higher tax-exempt income.

Sectors to watch

We have a constructive outlook on taxable munis. The supply-demand imbalance we observe in the tax-exempt market is even more noticeable. The low primary issuance and issuers using the extraordinary redemption feature to refund outstanding taxable bonds have reduced the supply in this market, boosting valuations in the space. In addition, taxable munis are generally more resilient from a credit stability perspective than their corporate counterparts in the event of an economic slowdown.

Furthermore, in this environment, we favor specific credit sectors within munis in general:

Affordable housing

The need for affordable housing combined with fiscal support has set the stage for an uptick of supply in this sector, where occupancy rates have remained very high. In addition, many of these projects benefit from call protection, which mitigates prepayment risk. The stable nature of these projects and the over-collateralization of their loan portfolio present a relative value for investors looking to be part of the housing shortage solution while generating excess risk-adjusted returns.

Permanent school financing

Texas Permanent School Fund is a program established by the state government to fund the state’s public schools perpetually. The fund was established to lower borrowing costs for Texas schools and charter districts of the state, and once granted admission into the program, benefit from AAA-rating and the backstop of the bond guarantor. The bonds benefit from the credit enhancement of the bond program itself and are priced relatively attractively from a relative value standpoint for AAA-rated credit. We view this sector as a good, high-quality fit for investors looking to add duration but who may be hesitant to add credit risk given its strong credit fundamentals.

Continuing care retirement communities

We view this sector as relatively attractive in the high yield space. These facilities have seen occupancy rates bounce back, and new builds are quickly closing their vacancy rates. In addition, cost pressures from staffing shortages have subsided and become more manageable for these providers.

¹ Bloomberg US Corporate Bond Index, September 2024.
² Bloomberg U.S. Aggregate Index, September 2024.
³ Bloomberg U.S. Corporate High Yield Bond Index, September 2024.
⁴ Bloomberg U.S. Treasury Index, September 2024.
⁵ Bloomberg Municipal Bond Index, September 2024.
⁶ Bloomberg Municipal Index Taxable Bonds, September 2024.
⁷ Bloomberg Municipal Bond High Yield (Non-Investment-Grade), September 2024.
⁸ JPM Research, September 2024.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Indexes are unmanaged and have been provided for illustrative purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.

AA-041024-184000-1