The cruelest month? Municipal bond (muni) investors would probably say November. Following the sell-off that began when Donald Trump won the US election, Muni investors might be a little hesitant to weather the storm. This sell-off appears to be running out of steam, however, and investors who sell now may soon regret it.
History favors the muni market
The municipal market is built for recovery. While a narrow investor base makes municipal bonds susceptible to sudden downturns, like the one that shaved almost 4% off the market in November, this is a market that historically bounces back. Usually this happens quickly, sometimes in less than a year. The rebound may therefore already be underway. History also indicates that higher income eventually overcomes price declines, leading to positive returns. Ultimately these are key reasons why muni bonds are an essential building block of a portfolio that prioritizes safety.
There are adjustments that skilled portfolio managers can make to stay ahead of the curve, especially as more details unfold about Trump’s plans to cut taxes and boost spending. Here are five steps investors may want to consider to keep muni portfolios safe:
Some investors try to protect their portfolios from rising rates by building a ladder of passive muni strategies. While ladders are static, market conditions are dynamic. Today’s elevated volatility and uncertainty make active management essential.
Trump wants to cut federal tax rates. With Republicans in control of Congress, he may very well succeed. Yet, details are still hazy, which will keep the market volatile. The ability to use taxable bonds with agility can help investors preserve capital.
Buy consumer inflation protection
Lowered taxes and Trump’s trillion-dollar infrastructure plan could lead to higher inflation. For investors who pay US taxes, buying Treasury Inflation-Protected Securities isn’t an ideal way to shield a bond portfolio. Instead, a muni portfolio that gets inflation protection through consumer price index swaps may be more tax efficient.
The municipal bond market appears to have priced in a hefty decline in tax rates already. Investors can play it safe by reducing their portfolios’ average maturity and their holdings of long-maturity bonds. This limits exposure to falling tax rates and rising interest rates.
Add some credit
If you, like the markets, believe Trump’s policies will stoke economic growth, consider adding mid-grade and high-yield municipal bonds. The issuers of these bonds should thrive in an improving economy: over the last five Federal Reserve tightening cycles, municipal credit has outperformed municipal high-grade securities.
Normally, municipals are less volatile than Treasuries and corporate bonds. With a Trump tax cut already priced into municipal bonds, expect the market to stabilize in the weeks ahead.
While markets are acting on the assumption that a tax cut is a done deal, it is important to keep in mind that it took six years to pass the last major tax reform during the Reagan administration. It may not take as long this time, but that doesn’t mean it will happen immediately.
In the current environment, it is understandable that not every investor is comfortable committing capital. Even for those who can’t bring themselves to buy into the current market, history shows that this is not the time to sell either.
To learn more about responsible investing, including the best ways keep your municipal bonds safe, visit AB (AllianceBernstein).
This article was produced by AB and not by the Quartz editorial staff.
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.