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Portfolio Manager Dennis DiCicco, of Manulife Investment Management, discusses the recent performance of the municipal bond market and his outlook given the substantial federal stimulus and other developments.
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Dennis DiCicco:
The first quarter of 2021 is a great example of the diversification benefits provided by the municipal bond market. In Q1, corporate bonds were down 4.49%, and US Treasuries were down 4.61%, while the municipal bond market overall was down just 0.35%. This outperformance of over 400 basis points was driven mostly by the technical environment that had manifested itself through $30+ billion in inflows over the quarter, the anticipation of higher income taxes going forward, as well as the continued credit improvement from outsized revenue surprises, as well as federal stimulus. This highlights how munis aren't directly tied to U.S. Treasury volatility and often lag U.S. Treasury moves, as well as the high-quality nature of municipal bonds relative to other fixed-income asset classes. Even more glaring is the triple B muni return of 1.38% positive, while corporate triple B's sold off by 3.8% in the first quarter.
Again, this alludes to the lower U.S. Treasury correlation, along with the vastly different supply and demand technicals that can insulate the municipal market from interest-rate volatility. Lastly, I want to make note of how important asset allocation and security selection is in this type of market environment, as evidenced by the fact that airports and transportation sectors had both been the only two positive performing municipal sectors year-to-date, while triple A rated bonds, as well as local general obligation bonds are two of the worst performers so far this year in 2021.
Given the current market environment, we've been focused on individual security selection and maintaining healthy overweight positions in sectors that are poised to benefit the most from not only economic reopening, but federal stimulus, as well as the potential for infrastructure spending in the near future. Transportation sectors, while having outperformed the broader market to date still have room to outperform relative to some of the high-quality, general obligation sectors within the market—mainly due to where current valuations stand today. We also see opportunities in healthcare, affordable housing, as well as some of the geographic areas that have a higher dependence on tourism. As some of these areas of the market were battered by COVID and will benefit greatly from reopenings and stimulus.
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