Periods of elevated economic stress can often show the true resiliency of investments. We think this COVID-19 pandemic is no different. Balance sheet deterioration, widening credit spreads, and illiquidity reflect just some of the many market symptoms that may appear during periods of distress. But for municipalities, we believe there are a number of countercyclical levers available to help stabilize credit quality, suggesting that municipal bonds may prove valuable for a fixed income allocation when times are tough.
Municipal bond issuers benefit from having access to federal funding, budgetary discipline, and diversified revenue streams, all while maintaining rainy day reserves to help buffer against deep economic downturns.
Benefits of Municipal Bond Issuers:
These multiple defensive features have allowed state and local governments to sustain remarkably low default rates through a variety of economic conditions. As is true of football, in munis the best offense is a great defense.
SOURCE: GSAM. As of November 30, 2020. Chart shows the countercyclical fiscal measures available to US municipalities to help minimize economic stress throughout different phases of a business cycle. ‘UI’ refers to unemployment insurance.
We believe the resilience of the municipal complex also extends to periods of legislative uncertainty. Municipals have been the asset class most consistently impacted by elections. However, the impact is rarely binary. To be sure, some scenarios would herald outcomes that are larger (or smaller) in consequence, but as a general rule most legislative shifts incur a one-time, short-lived technical moment for the municipal market. Not surprisingly, we believe the congressional composition from recent US elections is likely to have limited impact on the municipal market in 2021.
SOURCE: GSAM. As of November 30, 2020. Chart shows the impact of potential policy on the US municipal bond market. ‘State and local tax (SALT) deductions’ refers to the 2017 Tax Cut and Jobs Act that instituted a $10,000 cap on the amount of local taxes that may be deductible on federal taxes. For illustrative purposes only. These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation.
Even in a year with significant political and economic turbulence, municipals have remained fundamentally intact.