Midterm elections: Five factors for muni investors to watch

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While the national news media focuses on different horse races for control of the U.S. Congress, municipal bond investors will bring a wider perspective to this year’s midterm elections.

Voters in states across the country will choose their next governors and weigh in on various ballot measures that are likely to affect how much municipalities are able to borrow and what yields may be available to municipal bond investors.

Here are the five factors we’ll watch as the midterm results come in:

1. Focus on governors’ mansions

A majority of states—36 in all—will hold gubernatorial elections on November 6. In a typical midterm cycle, the party of the current president usually doesn’t do well in gaining gubernatorial offices. So, we expect to see some Democratic victories in key governor’s races this year.

Each state has its own financial challenges, and many states are currently in strong financial positions. But others face wide-ranging financial pressures from infrastructure needs to underfunded pensions. State legislatures are wrestling with priorities: should they shore up pension problems first or focus on capital expenditures like infrastructure?

This may be less of a pressing question in states where pensions are on more solid ground, but in states in direr financial situations we may see capital projects pushed aside in favor of funding public sector pension. The federal government could provide a hand here, helping states lower the costs of infrastructure financing.

2. Four states to watch closely

Two of the more interesting governor’s races for municipal bond investors to watch are in Illinois and Connecticut. Both contests are closely watched as both states have weak municipal credits and are among the more troubled states in regard to state pension funding levels.

But Illinois and Connecticut face different paths going forward. In Illinois, the economy is doing relatively well. Consider what’s happening in Chicago: A number of Fortune 500 companies recently moved their headquarters into the city (i.e., Boeing, ConAgra, McDonald’s) and construction is booming. But the state government also went through a two-year budget battle between the Republican governor and the Democratic-controlled statehouse that led to a downgrade of Illinois’ bond rating.

If Democrats win Illinois’ top office, the party will have a supermajority in the state. That should allow Democrats to build enough consensus to tackle the state’s ongoing pension problems.

Connecticut, on the other hand, is facing both a political and economic impasse. Economic growth has been slow to recover to pre-recession levels. Business activity and job markets are anemic compared with other states. Adding political gridlock to their economic problems gives Connecticut lawmakers less room to maneuver.

Voters in California and Colorado have the opportunity to weigh in on several ballot measures that would green-light bond issuance for the funding infrastructure projects. Californians will choose whether the state can borrow up to $16 billion to pay for water system upgrades, hospital expansions and affordable housing projects. In Colorado, voters will have their say on funding road and bridge improvements through approximately $10 billion of bond issues plus a sales tax increase.

3. Will regional interests shift?

Citizens in four states—Idaho, Montana, Nebraska and Utah—will decide on statewide measures to expand Medicaid. These are four solidly Republican states where voters will weigh in on one of the core components of the Affordable Care Act (i.e., Obamacare). The outcomes of these initiatives will impact the bottom line performance of health care systems in these states.

Additionally, there are gubernatorial elections across the Midwest in traditionally strong Democratic states that flipped for Trump in 2016. In particular, we see the governor’s races in Michigan and Wisconsin as important for municipal bond investors to watch. Both states went for Trump in the presidential election but could put Democrats in the top statewide offices in the midterms.

There’s also interest in the New York governor’s race, where the incumbent governor Cuomo has a sizeable lead over his opponent. His margin of victory could tell us a lot about the split between the state capital, Albany, and NYC.

4. The House hangs in the balance

Municipal bond markets will also have an ear tuned to federal elections, where GOP victories in a majority of House races could spur further tax reform and another shot at repealing the Affordable Care Act.

Health care measures are often driven more by federal mandates than statehouse legislatures. If Republicans can hold their Congressional majorities and manage to repeal Obamacare, we’ll see an impact throughout the health care market, but especially in those states that have passed Medicaid expansion.

Democratic control of the House raises the potential for federal gridlock, but we see opportunities for bipartisanship, especially on issues like infrastructure that hold high appeal to broad constituencies. Cross-aisle agreement on big-picture projects like infrastructure is possible, as evident in the bipartisan bill signed by President Trump in October, authorizing increased funding for water system infrastructure.

5. What to expect after the midterms

As municipal bond investors, when we consider possible outcomes for the midterms, we assess how different results could impact a state’s market perception and bond ratings. Will the agenda of a new or re-elected governor, whom we consider essentially the CEO of the state, lead to potential upgrades or downgrades? That’s what influences the spread of municipal bonds, from those issued at the state level down to cities and counties on a more local level.

We ask two questions whenever we look at a municipal bond opportunity. First, how is the state and region doing economically? Second, will the political climate enable state office holders to positively utilize the economic activity they have?

As an example, consider the recent gubernatorial election in New Jersey. The state’s bonds performed well after voters installed a new Democratic governor, with the expectation that Governor Murphy could work more easily with the Democratic-led state legislature and build consensus to tackle some of New Jersey’s thornier financial issues.

This scenario could repeat in states like Illinois, where one-party control of the governor’s mansion and the statehouse could pave the way for solutions to long-standing funding issues, improving the state’s municipal bond outlook.

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MacKay Municipal Managers™ team of MacKay Shields is co-headed by John Loffredo and Robert DiMella. John and Robert previously headed the largest municipal asset management group at Merrill Lynch Investment Managers/BlackRock. John and Robert have experience managing municipal assets across institutional separate accounts, open-end and closed-end funds

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