Views on the recent dislocation and the opportunity it presents
The dislocation due to fears of COVID-19 has been felt in all markets. The municipal market has seen a dramatic sell-off that sent municipal yields sharply higher over the past few days. The sell-off can be attributed to a combination of factors including outflows from high yield and investment grade funds and less liquidity in the global markets. The municipal market is oversold and is now trading at valuations not seen since 2008-2009.
The recent sell-off in the municipal market has been driven by illiquidity in the broader municipal, corporate, and equity markets. The magnitude of the downside price action experienced this week is very similar to 2008. Yet, the fundamental credit quality of most municipal subsectors is strong and well-positioned for a period of stress.
The macroeconomics supporting most of the municipal bond subsectors in which we invest will be able to sustain the projected downward pressure from reduced economic activity arising from the COVID-19 spread and mitigation efforts.
Over the last week, municipal yields rose 75-100 bps across the curve and credit spreads are wider.
Municipal mutual fund flows, which had been continuously strong for 61 weeks, reversed course as $1.4bn came out of funds. Bonds out for the bid, which had been averaging $685mn per day over the past year, started picking up last week and averaged $2.5bn over the past three days. With sustained outflows creating a steady stream of bid wanteds and constrained liquidity, the market struggled to find clearing levels, and cheapened to ratios not seen since 2008.
Municipals are now trading at exceptionally cheap levels relative to U.S. Treasuries which has created a significant opportunity for long term bond investors. Their valuations belie the underlying strength of the sector.