As lending tightened after the collapse of Silicon Valley Bank and as job growth has slowed, the Fed may finally be seeing the cooling of the economy it set out to orchestrate.
For investors, it’s time to re-examine the shifted landscape, say two fixed-income managers at Los Angeles-based Capital Group, and they say one of the best places to look for some stability is municipal bonds.
Karl Zeile, a portfolio director at the firm, and Greg Ortman, an investment director, write in a report called “Recession Resilience: Muni Bonds Can Help Shield Portfolios” that while many high-quality bond sectors can do well in a recession relative to equities, municipal bonds have some unique advantages that could make them shine in an otherwise dismal investment environment: For instance, they offer some resistance to recession impacts, and they offer high current yields and strong post-pandemic fundamentals, all of which act as a buffer if economic growth continues to slow and recession fears mount.
Zeile wrote would happen if the U.S. entered a recession. “I would expect equities to experience a correction due to the pressure on earnings,” he said. “The job market may weaken, causing a cash crunch for consumers, and economic growth would further contract.”
While that sounds unpleasant, those are pains that lead to municipal bond gains. The services supported by municipal revenue bonds tend to be essentials, like water and sewer services, garbage collection and tax collection. Consumers may skip a lot of things, but the essentials are the last to go, and that gives these bonds some resistance to recession.
“When recession knocks at the door with a car payment, credit card and a water bill due, everyone wants the ability to take a shower,” Ortman said. “People might not dine out at a restaurant, but they will open their wallets for water, electricity and gas to avoid shutoff.”
In addition, municipal bond yields are still at or near decade highs. At the end of March, the Bloomberg Municipal Bond Index saw its “yield to worst” (the lowest possible yield on a bond apart from default) hover around 3.25%, the authors said, and the likelihood of negative returns even in the wake of market shocks is less than it was a year ago. And, as always, the income on the investment in munis is federally tax-free—and sometimes tax-free at the state level as well.
Add to that the fundamental strength of the municipalities issuing these bonds, and this corner of the fixed-income market is unusually flush. The federal government disbursed billions of dollars to tribal, local and state government through the pandemic, and those strong balance sheets buoy the general obligation side of the muni bond market.
Still, not every sector deserves a buy, Zeile and Ortman said. For example, transportation agencies are still reeling from the pandemic and a recession. Similarly, healthcare and hospitals are still struggling with costs and staffing shortages.