September’s arrival focuses financial markets’ attention on approaching year-end performance and the 2018 investment outlook. Markets are still adjusting almost one year after the surprising 2016 presidential election. As reflected by the past several weeks’ performance of domestic stock indices, the robust equity “Trump rally” has decelerated into a “Trump stall.” In comparison, bond markets have tracked a more quiescent course this year following their decisive post-election sell-off. Interest rates are currently near their lowest levels of the year.
The municipal bond market has recouped the post-election 5.19% price decline from late 2016. The 2017 rebound is characteristic of prior municipal bond price recoveries that followed significant market declines. The Bloomberg Barclays Municipal Bond Index has climbed 5.20% through August, putting the municipal market back on its pre-election course.
Investor sentiment was particularly dour late last year. SMC FIM’s December 2016 Commentary, “2017 Outlook: Opportunity Amidst the Volatility,” highlighted potential risks as well as our contention that investors were overreacting: “With a new U.S. administration taking office, 2017 looks to be a year of many unknowns and the investment horizon more unpredictable. For anxious financial markets, the developing ‘Trump Revolution’ raises numerous questions that will not be answered quickly: tax restructuring, infrastructure spending, regulatory reform (Obamacare), pension liabilities, and new municipal debt issuance are considerations. Agenda advancement should be slower than many are now anticipating, and outcomes possibly not determined for a long time. The knee-jerk bond market reaction to the election outcome is overdone in our view. As 2017 unfolds, financial markets should return to a more balanced position.”
SMC FIM’s refrain (“Stay the Course - Again” in 2017) has proven to be the best course to follow this year. Our 2016 year-end note recommended that, besides staying the course, investors should take advantage of post-election offerings of sharply discounted tax-exempt bonds. We cited six reasons last December supporting our forecast for 2017.
Heading into the 2017 home-stretch, of the six reasons given to stay the course, only the last one (Strong U.S. dollar) has failed to materialize this year. Furthermore, the impact of Hurricane Harvey will negatively impact U.S. economic performance over the next few months.
The federal government’s borrowing capacity is now bumping up against another debt ceiling. Failure by Congress to act and raise the ceiling could severely impact the U.S. economy since the government’s bills will not be paid and its borrowing capacity halted. Given these additional uncertainties and the likely political fallout, the Fed should be reluctant to risk further exasperating matters by raising short-term interest rates again before year-end.
These reasons argue for staying invested, and the third reason (Bond market technicals will be supportive) presents the most compelling case. SMC FIM is concerned that the municipal market supply/demand imbalance could intensify, further lifting prices. Foregone tax-free income and possible price appreciation might be considerable. We do not foresee any significant impediments to market performance. Therefore, sidelined cash should be redeployed into the municipal market.
The information provided in this commentary is not intended to be a complete summary of all available data. Certain information contained herein has been obtained from published sources and/or prepared by sources outside SMC Fixed Income Management ("SMC FIM"), a division of Spring Mountain Capital, LP, and certain information contained herein may not be updated through the date hereof. While such sources are believed to be reliable, no representations are made as to the accuracy or completeness thereof by SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders, and none of the former assumes any responsibility for the accuracy or completeness of such information. Nothing contained herein shall be relied upon as a promise or representation as to past or future performance.
This commentary is neither an offer to sell nor a solicitation of an offer to purchase securities, any other investments or any other product sponsored or advised by SMC FIM, nor does it constitute an offer or a solicitation to otherwise provide investment advisory services. Such an offer or solicitation may be made only by the relevant documents for the relevant investment vehicle and/or investment program. This commentary is not, and may not be used as, a recommendation of any security, investment program or vehicle. There is no assurance that any securities discussed herein will remain in a client's account at the time you receive this commentary or that securities sold have not been repurchased. The securities discussed do not represent the client's entire portfolio and in the aggregate may represent only a small percentage of the client's portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed was or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
Statements contained in this commentary that are not historic facts are based on current expectations, estimates, projections, opinions and beliefs of SMC FIM. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Unless specified, any views reflected herein are those of SMC FIM and are subject to change without notice. SMC FIM is not under any obligation to update or keep current the information contained herein.
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