Munis Keep Rolling Along

The tax-free municipal market has been on quite a run. Driven by a solid technical backdrop, where inflows into the market have outpaced net supply, municipal valuations have reached extreme levels. One common way to judge the attractiveness, or lack thereof, of municipal bonds versus taxable bonds is to compare the yield levels between the two. For example, when analyzing the yield of a AAA-rated municipal bond versus a U.S. Treasury of a comparable maturity, we get a sense for how much investors are paying for the tax-free interest munis generate.

As seen in the chart below, this Muni/Treasury yield ratio has declined rapidly over the past several months, particularly for bonds with longer maturity dates.

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This market action has helped support the solidly positive returns in our municipal strategies this year. It has also led us to take profits in munis in our Blend strategy, by selling munis and reinvesting the proceeds into taxable bonds such as US Treasurys and corporates.

We are expecting the positive environment for munis to remain throughout the summer as June, July and August typically have the largest disconnect between supply and demand. However, for investors in mid-level tax brackets or for those without a state income tax to contend with, selling munis now and investing into taxable bonds provides added portfolio diversification without much of an after-tax income hit, making it an attractive trade for us.

Source: Barclays

Impact Insights: Curious About How to Begin Incorporating ESG and Impact Investing into Your Portfolio? Try Munis

A quick note: To highlight the SNW Impact Strategy through 2019, we will be periodically sharing thoughts and observations from the team responsible for the research and ratings. These pieces are intended to share the context of how the ratings are derived, the philosophy behind ESG and impact ratings, and how the industry is currently positioned. They may feature entities that we do not currently invest in.

You often hear it said that the first step is the hardest. But for investors and financial advisors looking to step onto the path to ESG and Impact investing, the first step can be an easy one—municipal bonds. Municipal bonds serve as a low-risk, tax efficient asset class that can dampen overall portfolio volatility and provide income. In addition to these favorable investment characteristics, when evaluating ESG and Impact opportunities, municipal bonds should be one of the first sectors that springs to mind.

Asset Class Characteristics

Most sectors of the municipal bond market, including tax-backed general obligation (think states, cities and counties) and various revenue-backed sectors (think utilities, hospitals, etc.), are amenable to ESG and value alignment investment approaches. Sectors such as education, healthcare, housing and utilities all have positive impacts, which investors pursuing such strategies will find attractive. The ability to invest directly in communities, in school systems, in renewable energy products, in clean water and in scores of other initiatives financed through the municipal bond market is a strong motivator for those seeking to achieve positive social and environmental outcomes with their investments.

That said, not all municipal bonds are impactful or ESG positive. Bonds financing prisons, detainment centers, fossil fuel power generation, hotels, shopping complexes and the like are also included in the municipal bond market. Even in sectors where a positive impact is possible, it takes a robust data collection and analytical effort to select bonds that achieve exceptional outcomes for the communities they serve. It takes an experienced team to evaluate the opportunities available and find those that are best suited for an ESG and Impact investing strategy. ESG factors that are material and relevant to the credit profile of an investment opportunity are integrated into any strong credit analysis; beyond this, identifying opportunities where financed projects can have a demonstrable positive effect on the surrounding community takes experience.

Investment Performance

One common question we receive around ESG and Impact investing pertains to the amount of performance sacrifice for incorporation. Based on our experience, when managed properly, the answer is none.

For bond investors, keeping the primary risk factors (interest rate and credit risk) consistent between the ESG/Impact and non-impact equivalents in each of our strategies has resulted in comparable performance and volatility metrics. At its core, other than the ESG and impact focus of the securities selected, the strategies are almost identical, making it easy to use this asset class as an initial entry point into ESG and Impact investing.

Source: OFI Global, 4/30/19. SNW composite information is net-of-fees and covers the 5-year period from 4/30/14 - 4/30/19. The Sharpe Ratio Calculation is shown gross-of fees. The performance information presented constitutes supplemental information for purposes of the Global Investment Performance Standards (GIPS®). Past performance does not guarantee future results.

Source: OFI Global, 4/30/19. SNW composite information is net-of-fees and covers the 5-year period from 4/30/14 - 4/30/19. The Sharpe Ratio Calculation is shown gross-of fees. The performance information presented constitutes supplemental information for purposes of the Global Investment Performance Standards (GIPS®). Past performance does not guarantee future results.

Market Growth

ESG and Impact investing is a growth area, having seen a CAGR of 13.6% since 1995. As US SIF reported in its 2018 Report on U.S. Sustainable, Responsible, and Impact Investing Trends, "Total U.S. domiciled assets under management using SRI strategies grew from $8.7 trillion at the start of 2016 to $12.0 trillion at the start of 2018, a 38 percent increase. This represents 26 percent—or 1 in 4 dollars—of the total U.S. assets under professional management." As successful advisors already know, understanding the trends in the market and helping to lead client conversations to determine whether they are interested in participating are key.

Municipal bonds give financial professionals an easy way to begin the conversation, particularly when there are minimal differences in performance and volatility between the strategies. And for advisors using such strategies from SNW Asset Management, there are no differences in fees between the two options. This makes ESG and Impact investment grade municipal strategies an easy choice for that first step down the ESG and Impact investing path.

Source: SNW Research

Is Inflation Ready to Take Off?

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Unfortunately, the markets are no closer to answering this question after last week’s inconclusive data. As we have been saying, inflation appears to be the key to financial market performance moving forward, and we are scouring all the data trying to find some clues about its direction.

At his press conference on Wednesday following the most recent FOMC meeting, Fed Chairman Jerome Powell left the markets confused. Last year we were all excited about the prospect of more press conferences, more data points and more insights—but sometimes less is more.

In the March press conference, Mr. Powell voiced his concern that low inflation is one of the great challenges facing central bankers. Just one month later he downplayed concerns about lower inflation, saying that the current low numbers are merely “transitory.”  The markets were certainly looking for some guidance as to whether a rate cut would be offered later this year, and with his latest remarks some air was let out of that balloon.

Friday’s much anticipated non-farm payroll and related numbers were equally inconclusive.  They were inflationary, as payrolls climbed by a strong 263,000 in April, and the unemployment rate fell to 3.6%. Yet this was a mixed report, as the lower unemployment reading was due in part to the participation rate decreasing to 62.8% from 63.0%. And wages rose only 3.2%, which was below expectations. So yes, the economy is still doing fine, with the unemployment rate near a 50-year low and wage inflation disproportionately helping low income workers, but the data is perhaps not strong enough to convince the markets that inflation is ready to take off.

Waiting for inflation is not a game for the impatient. Inflation has been called by some clever strategists the “mother of all lagging indicators,” and it appears to be living up to this nickname. So pull up your comfy chair—this could take a while.

Sources:  The Wall Street Journal, Bloomberg, The Financial Times

The Economic Data Point that Really Matters Continues to Disappoint, which may be a Good Thing

The quarterly release of U.S. GDP (Gross Domestic Product) growth is typically a headline datapoint for economists and investors as the reading gives the broadest picture as to how the U.S. economy is performing. These days however, financial markets are largely looking past it, and instead focusing on inflation, which is the key to financial market performance moving forward.

Friday’s first quarter GDP report showed an economy that largely picked up where it left off in 2018. GDP grew at a 3.2% seasonally adjusted annual rate, which follows full year 2018 GDP growth of 3%. Details within the report showed a buildup in inventories and a boost from net exports as the main catalysts for the advance, while tepid consumer and business spending were offsets. Economists expect many of these items to reverse in Q2, which will leave growth closer to the 2%, still a healthy level.

Core inflation, as measured by the price index for personal consumption expenditures, rose at a 1.6% rate in March, well below the Fed’s target for 2% growth. This matters because the Fed, which holds a meeting this Tuesday and Wednesday, has noted that weak inflation is one of the key factors behind the current “pause” in raising rates, after predicting two rate hikes coming into 2019. Tepid inflation should allow the Fed to maintain this stance; this has been a key driver of the rally in both stock and bond markets this year. Should inflation accelerate, which most market participants are not expecting, we could see a return to the Fed induced volatility that defined the fourth quarter of last year. Until then, let the good times roll.

Source: Bloomberg, WSJ

Big Week, Smaller Numbers

Last week offered a limitless buffet of economic updates for those who cannot resist offers of all-you-can-eat! The Fed released minutes, the ECB held a meeting, the IMF came out with new projections, and for dessert large U.S. banks were grilled by Congress. The options were overwhelming!

But what to eat? Our pick of the news were IMF projections cooked up with a wide array of ingredients. The major points of their outlook are: after strong growth in 2017 and early 2018, economic growth slowed in the second half of 2018. After a few quarters of weakness, growth is set to stabilize by 2H19. However, despite the better news, most risks are still tilted to the downside.

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Global economic activity decelerated notably in the second half of last year due to well-known events. China slowed after enacting regulatory tightening to rein in their shadow banking system in conjunction with an increase in trade tensions with the United States, the euro area lost speed as consumer and business confidence weakened, car production in Germany turned down and Italian sovereign spreads widened. Overall financial conditions tightening as markets sold off at the end of 2018. Because of these events, the IMF reduced 2019 global growth forecasts to 3.3%, with advanced economies down to a smaller 1.8%.

The just released IMF global economic forecasts now indicate the possibility for a small increase in global growth in 2020. This improvement is correlated with the Fed’s pause on rate hikes, China offering some stimulus, improvements in global financial markets sentiment, and the anticipated stabilization in Europe as China (a major export market for Europe) turns the corner. Still, growth will not be uniform with advanced economies still weakening into 2020 and global economic improvements coming from emerging markets and developing economies.

Despite the expectation for global economic stability and some modest growth, the warning of risks to the downside and still slower growth in advanced economies does not make you want to save room for dessert. The litany of risks prompting caution include a further escalation of trade tensions, a sharp deterioration in market sentiment like in the 4th quarter, a reassessment of the Fed’s pause due to the reemergence of inflation, a no-deal Brexit and continued political discord due to rising inequality and the rise of populism.

Maybe it’s best to just skip dessert.

Sources: IMF, Bloomberg