Trends we are watching
At Cumberland Advisors, we like U.S. municipal utility bonds that do not have merchant business tied to energy. The drop in the fuel price should make coverage ratios stronger and these essential-service bonds more secure. The same logic applies to transportation-backed bonds, whether for airports or turnpikes. We have been wary of third- and fourth-tier universities for some time now. With demographics forcing lower enrollments, many of the lower-tier colleges that were able to charge high tuition during the boom college years will be forced into a Hobson’s choice. They will have to offer more financial aid to hold onto their existing students, cut tuition levels, or reach for a lower-academic quality of students. There is a “beggar thy neighbor” approach that is negatively affecting bonds in the college sector.
All in all, we expect a smaller amount of issuance in the coming year than this past year––mainly because there were fewer bonds issued in 2006 than in 2005, so there are fewer bonds to be called. However, if our expectation of further declining muni/Treasury yield ratios occurs, many advance refundings of older, higher-coupon bonds should take place. These refundings are currently held in check because of the negative arbitrage in place between muni and Treasury yields. A slew of advance refundings would boost 2016 supply.
Overall, muni credit quality continues to improve. We think that pension and budget issues in places like Illinois and New Jersey will be addressed in 2016.
John Mousseau, CFA, is executive vice presdent and director of fixed income at Cumberland Advisors in Sarasota, Fla., which supervises more than $2.4 billion in separate account assets for individuals, institutions, retirement plans, government entities and cash-management portfolios.