Top Five Municipal Market Insights for 2017
New federal legislation expected to be proposed in 2017 that, if implemented, could impact the municipal market includes: tax reform, repatriation of corporate taxes, student loan financing, deregulation of corporate actions, and healthcare reform. Uncertainty regarding these changes and the resulting impact on state and local governments could delay the budget processes, capital projects, and debt issuance of many municipalities. State and local governments with strong budget controls, long-term capital planning processes, and accumulated reserves will remain strong during this time. We believe that value will rise to the top in this uncertain market. With these uncertainties in mind, our five annual insights are as follows:
1. Innovative Financing Accelerates
We believe Public-Private Partnerships (P3) projects, a popular infrastructure financing structure outside of the U.S., will gain increasing momentum. The faster development pace of P3 projects combined with tax credit incentives will align well with the new administration’s infrastructure development agenda. While P3 financing may displace some traditional tax-exempt issuance, we believe that the acceptance of P3 projects will be a net positive for additional two-way flow in the municipal market. P3 projects should introduce a multitude of new entrants, including private equity, developers, and non-traditional buyers to the municipal market. We expect that these entities will be enticed by municipal financing attributes, including attractive yields (for both borrower and lender), exposure to long duration, low correlation, cash flow stability, and low default rates.
2. Liquidity Improves in the Municipal Market
We believe federal regulations and oversight of U.S. banking institutions will ease. As a result, we expect these entities will increase the amount of capital committed to trading activities, including the municipal bond market. However, we anticipate that a greater awareness of liquidity and capital costs will motivate those institutions to show greater preference for bonds rated by at least one rating agency. Therefore, we believe that the liquidity of non-rated municipal bonds will continue to decline.
3. High Tax States Outperform
We believe states with high income tax rates will outperform states with marginal to zero income tax. As federal tax rates are reduced, we expect municipal investors to become more keenly aware of the benefit of double exemption. We believe that demand for bonds in high income tax states will be even greater for those fiscally responsible state and local issuers that have maintained their credit strength. Outperformance of states benefiting from population growth momentum and underlying economic stability should protect investors against possible volatility from both legislative and market uncertainty.
4. Municipals Outperform Treasuries and Lower-Rated Credit Outperforms Investment Grade
We believe municipal to treasury yield ratios will decline during 2017, as tax policy uncertainty subsides. The relative value of municipal bonds, when compared to the taxable market, will move back to more normal historical levels. We expect that this outperformance will provide municipal bond investors with an offset against any negative impact of federal income tax rate reductions. Additionally, spread widening in the fourth quarter of 2016 in the BBB and lower-rated categories offers investors tremendous yield and potential total return opportunities in an uncertain market, where rates will likely be more volatile. Historically, lower-rated, revenue-backed bonds have outperformed general obligation and higher quality bonds in rising rate environments, as underlying fundamentals improve, spreads tighten, and ratings are upgraded.
5. Alpha Generation from Active Trading and Timely Execution
We believe the uncertainties of new legislation at the federal level will cause swings in perceived value across many sectors, especially healthcare and education. As such, we believe that security selection and buy/sell execution will be key to outperforming. In these types of markets, a nimble active management style should be better positioned to generate strong relative performance. Investors employing a buy and hold strategy or investments in funds that have become too large to maneuver effectively will not be able to adequately adjust to the market changes and may underperform in our view.
Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund’s portfolio. Active management strategies typically have higher fees then passive management.
Alpha measures a fund’s risk-adjusted performance and is expressed as an annualized percentage.
Before you invest
Mutual funds are subject to market risk and will fluctuate in value.
A portion of a municipal fund’s income may be subject to state and local taxes or the Alternative Minimum Tax. Funds that invest in bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner. High-yield securities (commonly referred to as “junk bonds”) are generally considered speculative because they present a greater risk of loss than higher-quality debt securities and may be subject to greater price volatility. High-yield municipal bonds may be subject to increased liquidity risk as compared to other high-yield debt securities.
Municipal securities risks include the ability of the issuer to repay the obligation, the relative lack of information about certain issuers, and the possibility of future tax and legislative changes which could affect the market for and value of municipal securities. Such uncertainties could cause increased volatility in the municipal securities market and could negatively impact the Fund’s net asset value and/or the distributions paid by the Fund. Securities purchased by the Fund that are liquid at the time of purchase may subsequently become illiquid due to events relating to the issuer of the securities, market events, economic conditions, or investor perceptions.
Credit Ratings: Standard & Poor’s rates borrowers on a scale from AAA to D. AAA through BBB represent investment grade, while BB through D represent non-investment grade.
This material contains the opinions of the MacKay Municipal Managers™ Team of MacKay Shields LLC but not necessarily those of MacKay Shields LLC. The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and opinions contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Any forward-looking statements speak only as of the date they are made and MacKay Shields assumes no duty and does not undertake to update forward-looking statements. No part of this document may be reproduced in any form, or referred to in any other publication, without express written permission of MacKay Shields LLC. ©2017, MacKay Shields LLC.
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New York Life Investments engages the services of MacKay Shields LLC, an affiliated, federally registered advisor, to subadvise several Funds. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. The MainStay Funds® are managed by New York Life Investment Management LLC and distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors LLC is a Member FINRA/SIPC.