With the recent market turmoil, there have been few fixed income asset classes that have experienced any sense of reasonable stability. The U.S. Corporate fixed income market, although off its wide credit spreads, is still 41 basis points (bps) wider year-to-date, led by energy (138 bps wider) and followed by telecommunications, media, and financials. Other than U.S. Treasuries, the most stable credit market has been the less-followed taxable municipal bond market, a trend I expect to continue despite what appear to be full valuations.
This week’s chart tracks the recent movement in option-adjusted spreads (OAS) of index-eligible taxable municipal bonds relative to long-duration corporate securities rated single A and above. We isolate this component of the corporate index in order to compare like-quality paper with a similar duration (the taxable municipal index is over 11 years in duration). Note that the recent back up in spreads has been noticeably more pronounced in the corporate space.
Because it is not a widely traded market, taxable municipal bonds exhibit less liquidity under “normal” market conditions and therefore require a pick-up in yield, which is largely reflected in the early months of this chart. However, during periods of market stress, taxable municipal bonds have often exhibited greater liquidity, relative to select segments of the corporate credit market as investors flock to safety, and as a result, seek out bonds in the municipal market for their perceived safer risk levels. For example, at times recently, it has been extraordinarily difficult for investors to transact in parts of the corporate financial and energy sectors within the fixed income market, with bid/ask spreads very wide and dealers only willing to work trades on an order-by-order basis.
Segments of the taxable municipal market are going to face various challenges in the coming year, including, likely declining levels of pension funding given market performance, and revenue pressures in energy-concentrated credits. Still, the risk appears more benign relative to the issues faced in the U.S. corporate bond market such as merger and acquisition activity (which drives heavy new issuance), declining earnings and rising leverage.
Key Takeaway: The taxable municipal market has weathered the recent market volatility better than the corporate credit market, all while maintaining decent liquidity. I like the risk/reward profile of this market during a time of relentless market volatility. I view it as a good way to achieve portfolio diversification and see the pockets of value in various sub-sectors within the taxable municipal market.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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