December 15, 2014
This week we contemplate the linkage between high yield municipal and high yield taxable markets, share some observations from the Massachusetts Investor Conference, and highlight our white paper on the SEC’s Next Move in Muniland.
Are High Yield Munis Immune from Taxable High Yield Troubles?
In last week’s Commentary we discussed the impact of declining oil prices on State economies. During the ensuing week, oil prices continued to decline. While the ultimate impacts on State economies (and their bonds) may take months to surface, the markets are re-pricing various asset classes to a new perceived oil price paradigm.
The decline in oil prices is hitting the taxable high yield market particularly hard due to the high concentration of energy related credits. The SPDR High Yield Bond ETF lost -3.8% on the week.
Over the last few months, numerous articles have focused on the linkages and disparities between high yield market and equity market valuations, and wondered which of the two markets was “right”.
For muni bond investors, the linkages between taxable high yield and muni high yield markets is worth examining in the wake of recent taxable high yield market volatility.
During the last year, many market pundits have advocated that high yield munis were “cheap” relative to other fixed income asset classes, particularly corporate bonds. Recently Bloomberg reported a recommendation by an asset manager to buy high yield munis citing a comparison to the yield on Iraqi bonds and stating “…Illinois and Michigan…are certainly not Iraq”. While we have doubts about the author’s understanding of the composition of the muni high yield market, the thrust of the recommendation is consistent with other market commentaries.
Anecdotal evidence indicates that a contributing factor to non-traditional and hedge fund interest in Puerto Rico credits has been the extra yield that Puerto Rico credits offer compared to other global credit opportunities. If other fixed income markets cheapen in response to the oil price drop, Puerto Rico may no longer be the fashionable trade for the hedge fund crowd.
The recent dramatic decline in the taxable high yield market prompts us to ponder the linkages between taxable high yield valuation and muni high yield valuation.
Tax-exempt Municipal High Yield ETF vs. Taxable High Yield ETF
(February ’09 = 1)
Source: Yahoo Finance, DIVER Data Solutions
Based on ETF pricing, the two markets are far from perfectly correlated, but the periods of weak correlation can be attributed to short-term (muni) market-specific events. The weakest correlations occurred in 2010/2011 (Meredith Whitney down trade and recovery) and 2013 (taper tantrum and Puerto Rico).
We are not making a market call, but raising a note of caution. The moves in the oil market and related securities have been massive, and the knock-on effects, while hard to predict, are also likely to be large. The narrow, technically driven muni high yield market can follow its own path for limited periods, but ultimately its performance is linked to the broader investment markets. If this performance turns negative, we risk the virtuous cycle of inflows/positive returns flipping to the negative cycle of outflows/negative returns.
Massachusetts Continues to Lead on Transparency; Time to Look at Locals?
Last week, we (Mike C and Mark H) attended the Massachusetts Investors Conference. Massachusetts has been a leader in transparency. In conjunction with last week’s conference, the Commonwealth announced the availability of a bondholder app (as Assistant Treasurer Colin MacNaught pointed out in jest, this will allow bondholders to check the Commonwealth’s finances as they wait on line at Home Depot on Saturday mornings).
The development on the app shows just how comprehensive the Commonwealth’s disclosure has become (and perhaps how little more room remains for improvement). One possible avenue for improvement would be expanding beyond the State level disclosure to include information on individual authorities and cities and towns. Recent initiatives by the New York State Comptroller and the California State Controller provide good examples of state level clearinghouses for local government data.
Among the speakers at the Conference was Dr. Michael Goodman, Director of the UMass Dartmouth Center for Policy Analysis. One of Dr. Goodman’s key points was that the improvement in the Massachusetts economy over the last few years has been concentrated around Boston.
A look at the county level DIVER Geo Scores confirms the regional pattern that Dr. Goodman has observed:
Massachusetts County Level DIVER Geo Scores
Source: DIVER Analytics-Data Access Module, DIVER Data Solutions
Boston area counties Middlesex, Suffolk and Norfolk (together with the Cape and Islands counties) are the strongest in the Commonwealth. Hampden (Springfield), Worcester, and Bristol (Fall River, New Bedford) are the weakest.
Charting the SEC’s Next Move in Muniland
Last week we (Gregg B) published a white paper which recapped recent SEC municipal enforcement actions and initiatives. The paper also offers a view on the possibility of future SEC focus on secondary trades to retail and non-sophisticated municipal market participants.
15c2-12 Financial and Operational Disclosure Document Filings
Source: MSRB DIVER Data Solutions
This week, the Lumesis team will be mostly local, with a couple of trips to New York.
Have a great week,
Managing Director, Credit, Lumesis, Inc.
CLICK HERE to Subscribe to the Weekly Commentary