Lind Capital Partners Municipal Market Commentary

Municipal Market Performance and Benchmark Rates:  Higher rates, elevated supply, and ongoing volatility proved too much for the municipal market in December as both the IG and HY municipal indices lost ground last month. The Bloomberg Municipal Bond Index (LMBITR) posted a loss of (1.59%) in December, paring back year-to-date gains, which ended the year +0.93%.  The Bloomberg Municipal High Yield Index (LMHYTR) underperformed it’s high-grade counterpart for only the third month this year, falling (1.79%) in December.  For the year, however, high-yield outperformance vs investment grade municipals was typically prodigious. The high-yield index returned 6.21% in 2024, outperforming the investment grade index by 28%.

While the AAA municipal scale may have slightly outperformed the US Treasury market in December, both curves bear-steepened as yields rose across the curve.  AAA municipal yields were anywhere from 29 bps to 35 bps higher on the month while UST yields were anywhere from 33 bps to 42 bps higher.  Given increasing uncertainty regarding Fed policy and its impact on the US Treasury market, we expect rate volatility to persist for the foreseeable future.

Fund Flows:   Flows into municipal mutual-funds finally relented in December amidst the ongoing rate volatilty and any year-end repositioning. Investment grade mutual funds experienced outflows during 3 out of 4 weeks this month, totaling close to $1B in outflows. High-yield funds fared better, experiencing outflows in 2 out of the 4 weeks, but monthly flows remained positive, totaling close to $250MM in inflows.  Notable for the year was the significantly disproportionate share of flows garnered by high yield funds,  undoubtedly due to historically attractive absolute yield levels.

Primary Market Supply:   New issue supply roared back in the first few weeks of December, following a lackluster November due to the US Presidential election. December debt issuance totaled over $33B, a 27% increase year-over-year, but largely in-line with the trailing 5-year average for the last month of the year.  The opportunity in the non-rated primary market felt even more pronounced as LCP evaluated 25 to 30 new deals in December, a 100% increase vs December 2023.  LCP’s principal and final new-issue purchase this month was an Ohio charter school that came to market with long-term debt priced with 6.875% coupon at $100, a tax-exempt yield of 6.875%. 

Lind Capital Partners Non-Rated Market Commentary

As we ring in the new year, we annually take the opportunity to look back and compare actual market events to our expectations, as well as look ahead to the coming year.

Looking back...

We entered 2024 with the expectation that rates would be relatively stable and trend downward, especially given anticipation of multiple Fed interest rate cuts.  Looking back, there was certainly more rate volatility than we expected.  This was largely driven by mixed economic data, fluctuating expectations on the timing and magnitude of the Fed “pivot,” as well as implications of the Federal election. Investment grade municipals traded in sympathy with the US Treasury market for much of the year. Within the investment grade and high-yield municipal markets, our expectations largely came to fruition.  We expected a more “normal” supply environment following subdued new issuance in 2023. Total municipal new issuance finished the year at approximately $490 billion, +40% compared to the prior year and the 5-year average. Elevated supply was consistent throughout the year in the investment grade market. However, the non-rated municipal market presented a different supply narrative.  While total non-rated municipal supply finished +12% compared to the 5-year average, a bulk came in the fourth quarter following three quarters of muted new issuance. We also predicted that demand for municipals (in particular, high-yield municipals) would be strong in 2024, as investors began to rotate out of cash parked in short-term risk-free assets and looked to “lock in” attractive yields. This was evidenced by positive fund flows through the year.  Attractive rates drove consistent inflows into high-yield municipal funds month after month.  While the supply/demand imbalance did lead to some yield compression, there continued to be very attractive investment opportunities in the range of 6.50% – 7.00% (compared to 7.00% – 7.50% we saw in 2023).

Looking Ahead…

A significant theme since the Fed began cutting rates in September has been the steepening yield curve. We expect this to be an impactful theme during 2025.  One implication of a steeper yield curve is an increased “cost of complacency” of hiding out in short-term investment vehicles.  The relative value of extending duration becomes more attractive and should continue to spur investor demand for higher yielding fixed income products (such as non-rated municipals).  In addition, high absolute yields in the non-rated market should continue to gain favor from investors compared to investment grade municipals.

With that being said, rate volatility seems to have become the norm. We expect this to persist, as Fed policy continues to affect investor behavior and the new administration in Washington begins to make tangible policy decisions.  In particular, focus on federal spending, the debt ceiling, and extending the 2017 Tax Act will be of focus for investors.

Within the municipal market specifically, we expect heightened new issue volume recur. Borrowers are continually adjusting to the “new normal” rate environment and borrowing costs. Capital projects need to move forward, both for investment grade and non-rated borrowers. As always, the balance (or imbalance) between investor demand and new issue supply will largely drive the non-rated municipal market. We can imagine a scenario where demand remains stable and consistent yet yields remain elevated due to heavy supply. Combined with a favorable credit outlook, particularly in our chosen sectors, these dynamics should create an attractive environment for investors.  We look forward to seeing what 2025 brings…

Lind Capital Partners Non-Rated Market Strategy (through December 31, 2024)

The chart above shows the increase in value of $1,000,000 invested in the LCP composite at inception (net of management fees and expenses) vs. the benchmark, the Bloomberg High Yield Muni (LMHYTR) as well as the Bloomberg Muni (LMBITR) indices (it is not possible to invest in either Bloomberg Index). Please contact us with questions regarding credit profile, returns, taxable equivalent yields or further portfolio information. Past performance is not indicative of future results.