Here’s our first take after the midterm elections.
The polls actually got it right, with the Democrats taking the House of Representatives and the Republicans enjoying a slight pickup in the Senate.
Divided government, with different parties in control of the House and Senate, has sometimes led to gridlock. It also tends to keep spurious legislation from being passed; and so overall, markets are OK with this outcome.
Regarding munis, we feel that this election certainly eliminates the concern that a Republican House would have introduced legislation to cut income taxes further. With the Dems in control of the House, that notion is off the table; and fears that tax-exempt munis would suffer price erosion from lower marginal tax rates should dissipate.
From a spending standpoint, the divided Congress will most likely keep the President’s spending in check, and this may slow the current rise in the deficit (a good thing from our perspective).
We’re still checking final results, but we know that California voters rejected almost $9 billion in bonds for water projects, and Colorado rejected over $3 billion in a transportation bond. There’s more to come on this issue of bond rejections, but our thought is that the specter of the SALT provisions of last year’s tax bill is forcing voters’ hands. If state income taxes and local property taxes are no longer deductible, anything that raises the level of spending and potentially higher taxes is likely to get a cold shoulder, as people’s EFFECTIVE taxes will rise in any case with SALT provisions.
We do believe that with the current low unemployment level, a national infrastructure program with federal subsidies is not needed and is now more unlikely with divided government. We have seen large infrastructure bond deals done in the past year in the municipal market, and the issuers have had no problem selling the bonds.
Coming out of the elections, we feel especially constructive about longer-term tax-free bonds. With longer tax-free munis yielding over 4%, and with a taxable equivalent yield of 6.35% and muni/Treasury yield ratios of almost 120%, we feel longer tax-free paper is a real bargain and continue to manage portfolios in a barbell fashion, with longer-maturity bonds being a focal point.
The large December and January reinvestment periods are almost upon us. Supply is running 15% behind last year, and that will be another positive force for the market, along with the core inflation rate, which has been dropping for two months.
More to come.
John R. Mousseau, CFA
President and Chief Executive Officer, Director of Fixed Income
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