2020 has picked off right where 2019 left off for tax-free municipals. According to Lipper, investors poured $2.89 billion into muni funds last week, the highest total since 1992 and the 53rd straight week of inflows.
The main story in the municipal market last year was the positive technical environment, where new issuance was subdued, and demand was strong. This combination helped the asset class log positive excess returns in 2019 and has brought valuations to levels that most would consider “rich.”
Look no further than the tax changes made as part of the Tax Cuts and Jobs Act (TCJA) of 2017. Under the law, the $10,000 cap on state and local tax deductions, the so-called SALT cap, has resulted in surprisingly larger individual tax bills for people in states with high income taxes (especially Democrat-leaning states like California, New York and New Jersey). Investors began to fully understand the impact when they filed their tax returns in 2019, leading to record inflows into municipal mutual funds that began in January 2019. We expect this trend to continue well into 2020, which should help support the market for the next several months.
We’ve reacted to this by bringing down the allocation to tax-exempt munis in our Tax-Aware, or Blend Strategy in favor of taxable securities that offer more attractive yields. In our tax-free strategies, we are generally favoring higher quality credits as credit spreads are relatively tight. In other words, we stand ready for when the tide moves out, as that is the type of environment where value becomes easier to find.
Source: Bloomberg, Lipper