MuniLand – State General Obligation Credits Present Opportunities as Late Cycle Haven

A flattening yield curve, tight credit spreads and positive but slowing employment growth are key indicators that the extended U.S. economic cycle may be reaching an end. In this investment environment state General Obligation and Appropriation bonds may present more reward than risk. States have sovereign powers to tax, promulgate legislation and reduce expenses, which better protects their bonds from economic forces compared to other sectors of the municipal market. For example, a toll road is dependent on vehicular traffic and toll fares. Vehicular traffic typically increases during periods of economic expansion, as a growing economy encourages more miles driven to work and a greater willingness to pay tolls. When an economy slows, jobs are lost, fewer people drive to work and freeways and surface streets become a substitute for tollways. States are also sensitive to economic conditions, but have the ability (and in many cases the “rainy day funds”) to manage through downturns better than highly economic sectors of the municipal market. Super high-grade states that structurally balance their budget, manage future obligations well and have management teams and political leadership with a demonstrated willingness to adjust to economic realities continue to be a stable source of risk-off exposure. On the other end of the spectrum are BBB rated states. BBBs exhibit dysfunctional budget and legislative processes, backlogs of unpaid bills and the potential of falling into the non-investment grade universe. While cheap to extremely cheap, these credits do not have the fiscal cushion to muddle their way through an economic downturn. There are also mid-range state credits that that have stabilizing credit pictures, demonstrate the political ability and willingness to tap new revenue sources and have economic fundamentals that are less volatile than the national averages. These states and associated tax-backed bonds offer value and are better positioned to handle a potential downturn in the economy.

Source: SNW Asset Management Research Team