March was a period of unprecedented volatility in the financial markets as investors became more and more aware of the economic impact of the Coronavirus. Investors were looking to sell just about every area of the market, other than Treasury bonds and bills. Equities were down nearly 30 percent. Treasury bills went from offering a yield of one and a half percent to actually having a negative yield. Investors were paying to have their money kept in what they see as the safest part of the market. U.S. municipals were not immune from the volatility. Investors ultimately withdrew nearly 23 billion dollars from U.S. municipal bond funds, with about half of that being high yield municipal funds. Investors were looking to sell individual bonds. The volume on some of the electronic trading platforms reached record levels. The most commonly used one had nearly 13,000 individual bonds out for the bid, about four times that of the normal amount.
As a result, municipal bonds reached unprecedented levels, with yields at higher levels than we’ve ever seen compared to other areas of the bond market. The one-year high grade municipal bond had a yield of literally 10 times that of a corresponding maturity treasury bond, historically it would be about 65 percent.
Muni Fundamentals are Sound Long-Term
In many ways, the stress we saw, the liquidity-driven stress, was similar to what we saw in 2008 or 2013. The difference was how fast it developed. Wherein a matter of weeks the amount of outflows impacting our market, while similar to 2008 and 2013 from a liquidity perspective, again happened so quickly. What is also similar to 2008 and 2013, is that we do not view this as a long-term credit problem. We do not expect defaults to pick up, we do not expect impairments to hit the market broadly. After the financial crisis, we certainly saw credit downgrades and we will surely see credit downgrades in this period. But the default rates, following the financial crisis, remain in line with historic averages at about zero-point two percent, remarkably low, reflective of the resiliency of the municipal asset class. We expect that ultimately that will be the case in the municipal market. What has been different about this episode of volatility, compared to ‘08 and 2013, was the speed at which the federal government responded, also. They were able to take off the shelf some programs that were developed in 2008 for the Federal Reserve to help liquidity. And they quickly acted to pass the stimulus act, which will include about $450 billion of support for municipalities. Those measures gave comfort to investors who haven’t been that active in the municipal market over the last couple of years. Banks and insurance companies who look at the relative value, look at the fact that municipal bond yields were very high compared to Treasury bond yields and corporate bonds and started buying.
Taking Advantage of Dislocations
We saw very strong performance in the last full week of March. Our yields actually declined in the municipal market by about one and a half percent as a result of that buying activity. Now, municipals, depending on the type of strategy, are down for the year 2 to 6 percent after being down in the month of March 5 to 10 percent. We are looking to take advantage of some of the dislocations. The market is still quite cheap compared to other areas of the bond market. High-grade municipal yields about 2 to 4 times that of corresponding treasuries. So, we think years down the road investors will look back on this period similarly to how they look back on the ‘08 period or the 2013 period, where those who are long term investors take advantage of it and have very strong returns in the years to come.
Terrance Hults is Co-Head of Municipal Portfolio Management at AB.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.