2020 Begins With Steady Fundamentals (January 29, 2020)

Robert Amodeo: Welcome to Western Asset Management's Municipal Market Review. Municipal bond investors enjoyed a very good 2019. The overall market was up about seven and a half percent and favorable U.S. economic conditions remain supportive of credit valuations. Here we are in the beginning of 2020 and municipal bonds are already off to a very good start as well. Our credit outlook calls for steady fundamentals. And you would expect that in a mature economy. Investment strategies in our portfolios remain focused on income by overweighting lower investment grade bonds with an opportunistic eye to below investment grade securities. As always, we're cautious on those credits with prices that are stretched beyond their fundamentals, even if those fundamentals are positive. Meanwhile, our yield curve positioning remains centered around intermediate and longer maturities. Stronger performance in the municipal bond market during the past handful of years raises the obvious question: should investors be increasing their credit qualities in their portfolio, moving from lower credit quality to higher quality? Our view is that reaching for higher quality securities within the municipal bond market, which is generally viewed as a safe have/lower return volatility in a marketplace that offers considerable tax advantages through income. Our view is that moving from lower quality to higher quality is just too expensive and that investors should, so long as they can conduct credit surveillance, remain focused on single-A and triple-B or the lower end of the investment grade spectrum. The balance between supply and demand will continue to be a topic of discussion during the upcoming months, as supply usually picks up during the second half of the first quarter of each year.

Deposits, though, into municipal bond open-end mutual funds, along with the demand from global investors for taxable municipal debt, should continued to match up very well versus supply. And, if not, continue along the pace that we've seen from the fourth quarter into the early part of 2020, where demand continues to outpace supply. And as we mentioned in the past, more than a handful of projects with questionable fundamentals were financed with municipal debt during the past few years. Unfortunately, a few of those loans are circling the drain, as we say and their operations are really proven to be unable to service their debt. And it's just another example that while there is opportunity in the high yield municipal bond market, there are also larger potential pitfalls. Again, another reason for active management and the ability to conduct credit surveillance within a marketplace with generally a low default rate. There are other issues of concern, of course, and some of the changes in municipal bond rating agency methodologies are becoming more prevalent. It's always a good idea for investors to be aware of these ratings. Yet we believe here at Western it's more important to be able to look through those ratings because the best investments surface by discerning value where others disagree. Now, we also ask investors not to put too much emphasis on sectors.That is transportation vs. health care vs. other types of of sectors, but rather focus broadly on the bond types, revenue bonds versus general obligation, for example.

An important discussion is filtering through the public finance pipeline, though, and it really stems from Puerto Rico and the related litigation as potential negatives for revenue bonds coming out of the Puerto Rico litigation. And this new debate about revenue bonds and how secure they are may change some investors perception of the risk, whether G.O.s are safer versus revenue bonds. Our view is that if wider credit spreads for sound credits within the revenue bond sectors begin to surface, that will just make for better value in those revenue bonds, especially for those that are unlikely to be ensnared in potential bankruptcy. Of course, the municipal bond market remains diverse, despite the significant macro factors that we all talk about, such as the high profile credit challenges, pension issues and re-ranking of potential credit risk or default risk revenues versus G.O.s. But the risk specific to particular regions are not acting as catalysts for the concern in a broader marketplace. And that is good news in the marketplace in our view will likely continue to react in the same way. So just to conclude, investors need not march the highest quality securities, which are often the most expensive. If you can conduct credit surveillance. Thank you very much.

Elissa Refold: Additional information about Western Asset's, municipal strategies may be found at our website. The opinions and views expressed in this audio are as of the date indicate. Such opinions are subject to change and may differ from others in the firm or the firm as a whole. This audio is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security or product. Statements in this audio should not be considered investment advice and are not intended to be relied upon as a factual prediction or forecast of future events or performance or a guarantee of future results. Likewise, past results are not indicative of future investment results. Employees and or clients of Western Asset Management may have a position in the securities mentioned.