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Municipal Monthly March 2017 Munis and the Markets • Municipals have posted solid results so far this year. Even so, PIMCO sees more attractive relative valuations in the muni market than we did just a few months ago, as we see some of the policy uncertainty in the muni market receding. • Across portfolios, we continue to emphasize revenue-backed sectors over general obligation debt which may be more subject to pensions and politics. MONTH IN REVIEW • Municipals posted positive returns in March, notching a fourth consecutive monthly gain as they continued to make up ground lost during the post-election sell-off. The Bloomberg Barclays Municipal Bond Index returned 0.22%, bringing its year-to-date return to 1.58%. • The Federal Reserve raised its benchmark lending rate for a third time since moving off the zero lower bound in December 2015. The market largely took the well-telegraphed rate hike in stride. Muni front-end rates moved slightly higher while long-end rates were relatively steady, leading intermediate and longer duration municipals to outperform. • Flows into municipal mutual funds remained positive while new issue supply picked up modestly. Year-to-date issuance of $88 billion was down 11% on a year-over-year basis versus the first quarter of 2016, as refunding activity fell. • Hospital bonds outperformed as congressional attempts to repeal the Affordable Care Act (ACA) failed. Many healthcare systems have benefited from a lower number of uninsured patients under the ACA, which has subsequently lowered bad debt and charity care expenses. • The Bloomberg Barclays High Yield Municipal Bond Index’s monthly return of 0.23% belied significant dispersion within the underlying sectors. High yield tobacco debt outperformed. A large refunding of California’s “Golden State” tobacco bonds boosted prices, as these bonds were called at par after previously trading at a discount. Conversely, Puerto Rico was the weakest segment of the muni market. The island’s federal oversight board approved the governor’s fiscal plan, which outlined deep haircuts for bondholders. The plan allocates approximately $780 million annually for debt service, a fraction of the more than $3 billion owed each year. The island’s general obligation securities fell to record lows following the plan’s approval on March 13th. MARKET SNAPSHOT Yield-toWorst MTD Return YTD Return Muni Yields Yield MTD Change YTD Change Bloomberg Barclays Muni Index 2.37 0.22% 1.58% MMD AAA 2-Year 1.02 0.06 High Yield Municipal Index 5.86 0.23% 4.06% 5-Year 1.55 California Municipal Index 2.22 0.19% 1.57% 10-Year New York Municipal Index 2.16 0.24% 1.48% 30-Year Muni Returns Treasury Yields Yield MTD Change YTD Change -0.19 US Treasury 2-Year 1.25 -0.01 0.07 0.05 -0.24 5-Year 1.92 -0.01 -0.01 2.25 -0.04 -0.06 10-Year 2.39 0.00 -0.06 3.05 0.00 0.01 30-Year 3.01 0.01 -0.06 MUNI MUNI YTD IG YTD HY $88 bn YTD +$1.1 bn YTD -6 bps ISSUANCE FUND FLOWS +1.58% RETURN +4.06% RETURN Source: Returns: Bloomberg Barclays indices, Yields: Thomson Reuters Municipal Market Data (MMD), Federal Reserve. Supply: Barclays, Flows: EPFR YTD CHANGE IN 10YR MUNI YIELD Munis and the Markets | March 2017 CREDIT IN FOCUS: Sanctuary Cities SECTOR RETURNS Select Sectors • In January, President Trump signed an executive order entitled “Enhancing Public Safety in the Interior of the United States” that threatened to cut off levels of federal funding to jurisdictions that do not enforce federal immigration laws. Since then, municipal investors have questioned what this order means for so-called “sanctuary cities” and states, many of which are large muni market issuers. • The executive order and the subsequent opposition response from several major city mayors has created headlines, but PIMCO believes that the muni market has correctly downplayed the issue so far. To be sure, federal funding represents a sizeable portion of many municipal budgets; most major U.S. cities receive 8-12% of annual revenue from the federal government. However, we believe that the amount of federal aid that can be impacted by this order is limited by legal precedent and congressional budget laws. Additionally, most major U.S. cities have the budget flexibility to offset the impact of potential funding cuts. Munis cheap 2016 General Obligation 0.26% 1.63% -0.23% -0.05% 1.00% -0.01% Revenue 0.23% 1.63% 0.43% Education 0.27% 1.63% 0.00% Healthcare 0.29% 1.70% 0.45% Industrial Development 0.44% 1.83% 0.93% Lease-Backed 0.22% 1.82% 0.40% Power -0.07% 1.31% 0.44% Special Tax 0.14% 1.42% 0.38% Transportation 0.31% 1.75% 0.60% Water & Sewer 0.20% 1.48% 0.34% HY Tobacco 2.05% 13.12% 4.44% HY Puerto Rico -5.55% -0.72% 11.40% Source: Bloomberg Barclays indices MUNICIPAL MARKET ISSUANCE 10yr ratio 10yr avg. 130% YTD Pre-Refunded MUNICIPAL/TREASURY YIELD RATIO 140% Mar '17 Monthly Supply 30yr ratio 30yr avg. 120% $50 110% $40 Billions 100% 90% New Capital $60 Refunding $31.3 $30 $20 Munis rich 80% $10 70% $- 60% '12 '13 '14 '15 '16 Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar '16 '17 '17 Source: Thomson Reuters Municipal Market Data (MMD) AAA yields, Federal Reserve Source: Barclays To receive this monthly update in your inbox, visit pimco.com/munis/subscribe PIMCO Muni Highlights 19 Years Managing municipal assets $38 Bn AUM as of 31 Mar ‘17 For more information, visit pimco.com/munis 17 Team members 50+ Firm-wide credit analysts 11 Mutual funds and ETFs Munis and the Markets | March 2017 Past performance is not indicative of future results. A Word About Risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. The Barclays Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long term tax-exempt bond market. The Barclays High Yield Index is an unmanaged market-weighted index including only SEC registered and 144(a) securities with fixed (non-variable) coupons. The Barclays High Yield Municipal Bond Index is a rules-based, market-value-weighted index that measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is not possible to invest directly in an unmanaged index. Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement. PMUNIMA03_49193 CMR2017-0417-263117 This material has been distributed for informational purposes only and 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. 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