The Fed: Q2 2024
Tax-Exempt Strategies:
Taking the Temperature on Municipals as Summer Heats Up
- Value in the tax exemption provides an advantage.
- Balanced technicals continue supporting prices.
- Credit resilience is increasingly important in security selection.
Investment grade municipals (IGM) closed out the second quarter in a neutral position as losses during April and May were offset by the strongest June monthly performance since 2016, per the Bloomberg Municipal Bond Index. Year to date, IGM delivered a respectable -.4% total return versus -.86% for U.S. Treasuries. Longer maturity and lower quality bonds were among the best performing areas of the municipal bond market. One bright spot in fixed income is the stellar performance of high yield municipal bonds (HYM). According to the Bloomberg Municipal High Yield Bond Index, the YTD total return was above 4% through 1H2024. The relative strength of IGM and HYM bonds this year is attributed, in part, to absolute yields that remain attractive despite the volatility in the financial markets. The value of the tax exemption tends to increase as yields rise. With currently available yields in IGM and HYM bonds bouncing around levels still higher than in years prior, taxable equivalent basis on these segments of more than 6% and 9%, respectively, are quite enticing for longer-term investors.
Chart 1: Municipal Bond Yields Remain Compelling
Source: Bloomberg, as of June 30, 2024. Past performance is no guarantee of future results.
Indexes are unmanaged and do not reflect a deduction for fees or expenses. Investors cannot invest directly in an index.
Information is subject to change and is not a guarantee of future results.
The technical backdrop for municipal bonds has turned very exciting so far this year. On the supply side, gross sales of more than $240 billion during 1Q and 2Q (about a 40% increase YoY) has provided investors with ample bond choices to put cash to work in portfolios. As issuers pull forward deals ahead of election uncertainty and feel more comfortable in the current interest rate environment (vs. 2023), supply is projected to remain strong at least in the near term. The absorption of supply is due to healthy demand for the asset class. Municipal bond mutual fund flows have continued to improve from the record outflows of 2022. On the year, net inflows have helped support the market, leading to more fully valued bonds and tighter credit spreads. The interplay between supply and demand could weaken after the summer as the election comes more into focus. Thus, our positioning is in line with respective benchmarks but with flexibility within our strategies to take advantage of rate scenarios.
Chart 2: Gross Municipal Bond Issuance, in $Billions
Source: Bloomberg as of June, 30 2024; projected = Bank of America and JPM revised forecasts Indexes are unmanaged and do not reflect a deduction for fees or expenses.
Information is subject to change and is not a guarantee of future results.
Municipal credit trends remain stable for most issuers of the market, but waning stimulus and economic moderation is beginning to impact revenue production for some state and local governments (SLGs). The ratio of upgrades to downgrades remains positive, but the margin has thinned over the past two quarters. However, we expect IGM quality to remain intact but focusing on more issuer-specific factors in discerning risk with an emphasis on the forward-looking view of individual credits. Robust reserves and liquidity should act as a buffer should budget imbalances surface. Within HYM bonds, we expect distress to remain low in comparison to the size of the market, but monitoring operating risk within certain sectors, like senior living.
Important Information
The views expressed represent the opinions of City National Rochdale, LLC (CNR) which are subject to change and are not intended as a forecast or guarantee of future results. Stated information is provided for informational purposes only, and should not be perceived as personalized investment, financial, legal or tax advice or a recommendation for any security. It is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While CNR believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations,estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.
Investing involves risk including loss of principal. The market price of a security may move up and down, sometimes rapidly and unpredictably. The securities of mid-cap companies may have greater price volatility and less liquidity than the securities of larger capitalized companies. Larger, more established companies may be unable to attain the high growth rates of successful, smaller companies during periods of economic expansion. Current and future holdings are subject to risk. There is no guarantee the fund will achieve its stated objective.
City National Rochdale, LLC is an SEC-registered investment adviser and wholly-owned subsidiary of City National Bank. Registration as an investment adviser does not imply any level of skill or expertise. City National Bank is a subsidiary of the Royal Bank of Canada. City National Bank provides investment management services through its subadvisory relationship with City National Rochdale. Brokerage services are provided through City National Securities, Inc., a wholly-owned subsidiary of City National Bank and Member FINRA/SIPC.
Index Definitions
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the US It is not an exact list of the top 500 US companies by market cap because there are other criteria that the index includes.
S&P 500 Growth: The S&P 500 Growth Index is a stock index administered by Standard & Poor’s-Dow Jones Indices. As its name suggests, the purpose of the index is to serve as a proxy for growth companies included in the S&P 500.
S&P 500 Value: The term S&P 500 Pure Value Index refers to a score-weighted index developed by Standard and Poor’s (S&P). The index uses what it calls a “style-attractiveness-weighting scheme” and only consists of stocks within the S&P 500 Index that exhibit strong value characteristics. The index was launched in 2005 and consists of 120 constituents, the majority of which are financial services companies.
S&P 500 Equal Weight: The S&P 500® Equal Weight Index (EWI) is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight - or 0.2% of the index total at each quarterly rebalance.
DJDVP: The Dow Jones U.S. Select Dividend Index aims to represent the U.S.’s leading stocks by dividend yield.
Bloomberg Municipal Bond Index: The Bloomberg US Municipal Bond Index measures the performance of investment grade, US dollar-denominated, long-term tax-exempt bonds.
Bloomberg Municipal High Yield Bond Index: The Bloomberg Municipal High Yield Bond Index measures the performance of non-investment grade, US dollar-denominated, and non-rated, tax-exempt bonds.
Bloomberg Investment Grade Index: The Bloomberg US Investment Grade Corporate Bond Index measures the performance of investment grade, corporate, fixed-rate bonds with maturities of one year or more.
The Nasdaq Composite Index is a market capitalization-weighted index of more than 2,500 stocks listed on the Nasdaq stock exchange.
The Russell 2000 Index is a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index.
The Bloomberg Magnificent 7 Total Return Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).
Definitions
Yield to Worst (YTW) is the lower of the yield to maturity or the yield to call. It is essentially the lowest potential rate of return for a bond, excluding delinquency or default.
P/E Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).
The 4P analysis is a proprietary framework for global equity allocation. Country rankings are derived from a subjective metrics system that combines the economic data for such countries with other factors including fiscal policies, demographics, innovative growth and corporate growth. These rankings are subjective and may be derived from data that contain inherent limitations. MSCI Emerging Markets Asia Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the Asian emerging markets.
City National Rochdale Proprietary Quality Ranking formula: 40% Dupont Quality (return on equity adjusted by debt levels), 15% Earnings Stability (volatility of earnings), 15% Revenue Stability (volatility of revenue), 15% Cash Earnings Quality (cash flow vs. net income of company) 15% Balance Sheet Quality (fundamental strength of balance sheet).
*Source: City National Rochdale proprietary ranking system utilizing MSCI and FactSet data. **Rank is a percentile ranking approach whereby 100 is the highest possible score and 1 is the lowest. The City National Rochdale Core compares the weighted average holdings of the strategy to the companies in the S&P 500 on a sector basis. As of September 30, 2022. City National Rochdale proprietary ranking system utilizing MSCI and FactSet data.
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