Financial Industry Insights from Advisors Asset Management


AAM Viewpoints – Municipal Markets: No Height Requirement, but a Strong Stomach is Advised

The municipal bond market can be aptly described as a rollercoaster ride over the past several months. This applies to both the movement of yields and the emotional/mental toll it took upon participants. The below chart highlights the extreme volatility experienced by the markets and demonstrates the quick return to levels observed prior to the COVID-19 related turmoil as demonstrated by the BVAL Municipal AAA 10-year yield curve.

BVAL Municipal AAA 10-year yield curve 

Source: Bloomberg | Past performance is not indicative of future results.

The traditionally sedate municipal market experienced extreme yield volatility as the steady influx of cash suddenly changed course and investors sought to exit the market en-masse in mid-March. However, within a few days cooler heads prevailed and yields started to move back toward pre-crisis levels. Within one month, AAA-rated yields had retraced 85% of the selloff. By the end of May, they had retraced nearly 100% of the panic move. So, all is good in the municipal market and investors can go back to business as usual, right? Not quite. This only tells part of the story….

As is typical during periods of market volatility, credit spreads (the yield premium investors receive as compensation for credit risk) widened significantly. The below chart demonstrates the spread in basis points between Single-A rated revenue bonds and the generic AAA yields on 10-year maturities as calculated by the Bloomberg BVAL Index. Charts for other Single-A rated credits and even lower rated BBB credits appear to demonstrate a very similar pattern, so this comparison is a solid proxy. Prior to the selloff, credit spreads were at their narrowest levels over the past five years (red circle). Unlike the previous chart showing absolute AAA yields, however, credit spreads have not returned to pre-crisis levels (green circle). Thus, yields on lower-rated credits have remained elevated as the market sorts out the long-term effects on issuers from the coronavirus related economic shutdown.

Bloomberg BVAL Index 

Source: Bloomberg | Past performance is not indicative of future results.

What can we conclude from this and what should investors consider doing moving forward? We believe this pattern should be expected to recur during future periods of market volatility. Therefore, when credit spreads again narrow (which we fully expect to occur at some point), we believe investors should consider seeking to sell lower-rated credits (ideally after having enjoyed outperformance and positive returns) and focus on reinvesting into quality credits within portfolios. A focus on total return portfolio management has the potential to smooth out the chaos and position investors to “buy high, sell low” (in terms of yields). Then, after the selloff and during the period of market weakness, we believe investors should consider focusing on taking advantage of the yield premium on “better quality” lower-rated credits. The key is to understand the underlying fundamentals of the issuer and make sure that the risk/reward trade-off is favorable. Not all Single-A rated credits are the same. There is a wide disparity between credit quality within a given credit rating and a wide disparity within sub-sectors of the market. For example, not all healthcare-related credits are worth avoiding depending on the underlying relative soundness of the issuer and their expected ability to return to “normal” post COVID-19.

We believe investors who plan ahead by positioning their portfolios to optimize performance under different market scenarios – and avoid a panic reaction when turmoil arises – have the potential to not only survive future incidents but capture positive returns as a result.

This is not to suggest that thrill seekers who enjoy amusement park rollercoasters should seek the same thrill in the municipal market. However, investors can benefit from understanding the risks and opportunities when the market becomes over-bought or over-sold and not getting scared of the rollercoaster-like volatility.


CRN: 2020-0511-8293 R

An investment in Municipal Bonds is subject to numerous risks, including higher interest rates, economic recession, deterioration of the municipal bond market, possible downgrades, changes to the tax status of the bonds and defaults of interest and/or principal. A bond’s call price could be less than the price the trust paid for the bond. Bonds typically fall in value when interest rates rise and rise in value when interest rates fall. Bond insurance covers interest and principal payments when due and does not insure or guarantee the value of any bond in any way.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit


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