December 9, 2020 | Vanguard Perspective
Some investors may have read negative headlines about falling state and local government tax revenues. While revenues have generally decreased since the onset of the pandemic, issuers have responded quickly by using reserves, cutting expenses, and borrowing in the market in order to bridge these gaps while the economy recovers. As a result, stability has returned to the market, with municipal bond prices rebounding strongly amid robust demand.
Concerns about weaker issuers will persist in the high-yield space and the benefits from the path of economic recovery will transmit unevenly across sectors. But the story of the effects of the pandemic on municipal credit, particularly among investment-grade issuers, will read of downgrades and not defaults. We believe the municipal bond market—a crucial component of the funding mechanism for key infrastructure and services such as public education, health care, and transportation—will continue on its road of recovery.
We see the majority of municipal issuers continuing to use all of the tools at their disposal to pay their debt service. Here’s why:
Our municipal team at Vanguard—with its deep expertise and tenure over several market cycles—remains selective and opportunistic. We add value through our ability to analyze sectors and individual issuers in the market, while taking potential downgrades and fiscal effects into account. We look to add bonds at favorable prices from issuers with strong long-term prospects for recovery.
For example, one sector where we see opportunity for our active funds is in toll roads, which have generally weathered the pandemic well because of ample liquidity, yet sold off as a result of fears of traffic decreases. According to Moody’s Investors Service, toll road authorities had enough cash on hand to cover a median of 900 days of expenses in fiscal year 2019.
In addition, commercial traffic, which typically pays higher tolls than passenger traffic, has performed very well throughout the pandemic and, in some regions, has already fully rebounded. Passenger traffic has rebounded from the lows experienced in April and is now down only about 20% year-over-year. The sector should continue to perform well even though traffic is not expected to recover to pre-COVID levels until 2023.
In the coming months, as President-elect Joe Biden prepares to take office, there will be renewed calls for additional federal aid, along with the potential for more negative headlines. The political process is a noisy one, but our team, supporting our national and state tax-exempt funds, will continue to go beyond the headlines and short-term volatility and focus instead on long-term credit fundamentals.
For us, the bottom line is: Despite the recent volatility, municipals remain a high-quality asset class that offers attractive tax-exempt income with the opportunity for vigilant active managers to capture mispriced bonds and add value for clients.
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