During the recession and for years afterward, many U.S. cities experienced a shortage of tax revenues due to high unemployment and low property values. Despite the fact that we still read about troubled regions, such as New Jersey and Chicago, it’s important to recognize that most U.S. municipalities have recovered well. As a result, the municipal bond market is thriving, with nearly 50,000 issuers in the U.S.
Municipal bonds were among the top-performing asset classes in both 2014 and 2015. We believe the silver lining in a slow recovery is that spending remains relatively constrained even though income and property taxes are on the rise. For investors in high tax brackets, the demand for tax-advantaged securities, such as muni bonds, is high while net issuance continues to be low, creating a strong and stable market. Looking ahead, the following are a couple good reasons, in our opinion, to consider muni bonds in a well-diversified portfolio.2 Please remember that investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
It’s An Election Year
Bond interest payments are taxed as ordinary income, so rates today run as high as 39.6 percent. However, municipal bond income is not subject to any federal income taxes. With this year’s contentious election campaigns, Democrats and Republicans remain divided, not only against each other, but within the parties themselves. Therefore, no matter who takes over the White House, it is very likely our federal government will remain divided for at least another year. This means the chances for comprehensive tax reform are not particularly good, which is good news for muni bond holders.
Interest Rate Uncertainty
Now that the Federal Reserve is considering a gradual uptick in interest rates, longer-term bonds are poised to do very well if inflation remains under control. However, we believe intermediate bonds are perhaps even more attractive in that investors can profit from a steeper yield curve without exposure to the duration risk of longer-term bonds. When you add in the tax-advantaged coupon rate of municipal bonds, the risk of higher interest rates is further mitigated. 3
2 James Dearborn. Columbia Threadneedle. May 2, 2016. “Finding opportunities in today’s municipal bond market.”https://blog.columbiathreadneedleus.com/finding-opportunities-in-todays-municipal-bond-market. Accessed May 4, 2016.