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Advisors know that municipal bonds are one of the go to assets for clients nearing or in retirement. They also know that will munis are low risk, this corner of the fixed income market isn't perfect. Nor is it risk free.
On the income front, there are challenges. For example, the widely followed S&P National AMT-Free Municipal Bond Index yields less than 1% on a 30-day SEC basis. Of course, higher yields can be had, but that means taking on more credit risk. In muni land, that means exposure to debt issued by cities and states with higher default risk.
Keeping the political element out of this discussion, let's just focus on the fact that the American Rescue Plan President Biden signed into law last month features $350 billion in direct aid to states and local governments – many of which need it by way of their own doing.
The benefit to advisors and income-needy clients is that the bill shores up finances for some ailing municipalities and states while restoring some lost luster to once beloved munis.
Why Now for Munis
The $350 billion for state and local government support comes courtesy of the Treasury Department and could play a pivotal role in enticing advisors and retirees to revisit municipal bonds.
“Approximately 56% of the aid will be directed toward states, 37% toward local governments, and 7% toward tribal governments and US territories,” according to Invesco research. “The $350 billion in funds will be spread across the country, with more populous states receiving larger portions of the total aid.”
That deployment strategy is relevant because, not surprisingly, the larger states are usually the biggest issuers of municipal debt. As a result, many issue-weighted funds that advisors favor for broad-based muni allocations tilt toward those states. For example, the aforementioned S&P National AMT-Free Municipal Bond Index allocates over 51% of its combined weight to New York, California and Texas – three of the four largest states.
“This second round of federal stimulus should further stabilize state finances, since $195 billion is earmarked for states,” notes Invesco. “According to Moody’s, this amount is equivalent to nearly 16% of states’ own revenue posted in fiscal 2019.”
Not a Cure All, But Step in Right Direction
In recent years, advisors faced vexing propositions with municipal bonds by way of low yields and the specter of, albeit further off, massive pension default risk in some states that are major issuers of these bonds. All that means it's nice to get some one-off assistance, but some states still need to get their fiscal houses in order.
“However, the stimulus is substantial. While cumulative state tax losses are forecast to reach $31 billion in the current fiscal year, the federal stimulus being awarded to states is six times greater than this revenue loss,” notes Invesco. “State and local governments may use the stimulus money to reinstate funding where cuts had been made, replenish “rainy day” funds, or infuse momentum into their local economies.”
Bottom line: The combination of the aforementioned stimulus and GDP projections indicating the U.S. economy will grow more than 6% this year restore some shine to munis.
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