The Ballast Behind the Muni Market

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<h3>James A. Klotz</h3>

James A. Klotz

What provides peace of mind to municipal bond investors, especially those looking for a reprieve from the stock market tsunami?

It’s simple: The fundamentals. That is, the ability of municipal issuers to repay their debt.

When investors of muni mutual funds stormed the exits this year, it enabled buyers of individual bonds to purchase munis at yields not seen in years.

The ballast behind the muni market

They knew what many others missed: State and local governments are generally in good shape. They’ve bounced back from early pandemic fears of economic calamity and have strengthened their financial position.

Aid, growth a boon to finances

Key to their fiscal health was aid from Washington. In 2020 and 2021, while in the throes of the pandemic, the federal government funneled $500 billion to state and local governments via the Coronavirus Aid, Relief and Economic Security Act and the American Rescue Plan Act.

This unprecedented level of assistance helped ameliorate the fiscal calamity many predicted. States were able to balance their budgets and they avoided cuts for schools, health care and state revenue shared with cities.

These funds, coupled with strong economic growth and employment, swelled their coffers. In the first quarter of 2022, state and local government tax revenues were up 4.7% from the fourth quarter of 2021 and almost 16% compared with the first quarter of 2021.

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    Further, state and local balance sheets remain historically robust. Median fund balances for all Moody’s rated cities and counties stood at a healthy 41% and 38% of operating revenue, respectively, as of fiscal year 2020, according to Nuveen.

    Rainy day funds, which serve an important role in helping states withstand shifts in the business cycle, are also at favorable levels.

    In fiscal year 2021, states’ collective rainy days funds increased by $37.7 billion, for a then-record total of $114.6 billion. By the end of fiscal year 2022, rainy day funds are projected to reach $136.5 billion.

    With these savings alone, states could have run government operations for a median of 42.5 days, a new high, compared with 28.9 days in fiscal 2019, just before the pandemic recession.

    Attractive conditions for long-term investors

    Of course, no one can foresee the future. But state and local issuers have decades of experience providing essential services during a variety of economic conditions, which is appealing for those looking for drama-free investing.

    Conditions are highly attractive for long-term investors who value a good night’s sleep.

    Although their muni market values are temporarily depressed, they can keep their interest clock ticking while taking advantage of juicy yields and high-quality credits.

    James A. Klotz is the President of FMSbonds, Inc.
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    Oct 20, 2022

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