State and Local Government Fiscal Problems Have Improved
We are likely to continue to read about fiscal problems at the state and local level, including threats of defaults, union strife, pension abuse and reform, etc. This headline risk could contribute to periodic weakness in the muni market, and, as noted above, could contribute to “hot money” heading for the exits. But this isn’t a driver of our thinking, as there have also been encouraging signs relating to generally improving fundamentals.
While municipalities are not clear of their fiscal challenges, they have made progress in improving their fiscal credibility. We have seen many examples of higher taxes, pension reforms, public sector layoffs, and significant spending cuts (several hundred billion in expenses have been cut at the state level over the past three years) that are to varying degrees helping municipalities correct budget gaps between what they take in and what they spend.
Where Does That Leave Us in Terms of Owning Munis?
We make investment decisions for our client portfolios at the asset-class level based on a five-year analysis of risk and return across multiple broad, macroeconomic scenarios in concert with each portfolio’s 12-month downside risk threshold. Based on that analysis, we view munis as marginally unfavorable relative to other selective options in the taxable bond universe, even for investors in the highest tax bracket. While we don’t feel urgency to move aggressively or quickly, we are seriously considering a further incremental reduction in munis in favor of such taxable fixed-income options in the months ahead.