The market is in somewhat of an unprecedented space. Just when we thought levels could not go lower, here we are just a few basis points off the March lows in yield.
Last week’s Bond Buyer Revenue Bond Index was at 4.33% versus the low of 4.28% on March 28. The high-grade Bond Buyer 11-Bond Index registered 3.36% last week versus the low of 3.30% on March 28.
Even with a recent uptick in municipal issuance, there is a very good chance the indices will sink again this week. The primary catalyst for this recent history may be directly linked to the Fed’s pause on rate action and the persistent, more moderate issuance, versus a couple of years ago in the pre-Tax Reform era.
Despite these trends, market participants have been hanging on to ratios as the last salvation. If ratios continued to be “in the range” then all would be well. This last bastion of taking comfort in the steadiness of ratios is now being challenged.
As of this writing, the 30-year Muni/Treasury ratio has now dwindled to 89.1%. The short end of the one-year and the 10-year have already been exceptionally rich.
The trend probably will continue unless the market is tested with an unanticipated surge in supply. There is some hope that the savvy issuers in the market who are monitoring all of the trends may be compelled to come forward with more supply. Participants know there is no end to the necessity of projects. The rub, of course, is how to pay for them.
Equity markets are reaching new highs. The only sector in the equity world that has been negative for several days running during this rally is healthcare. Now granted, the equity healthcare component is quite a bit different from the non-profit healthcare sector that constitutes most of the municipal market.
For-profit entities and the pharmaceutical industry are not going to be highly correlated with the mainstream tax-exempt sector.
Sources on the Street have confirmed that spreads in the muni healthcare sector continue to be trending to the tighter side.
What is an investor to do? The industry is one of the best in being able to exploit pockets that are undervalued and out of step. The essential question is: are there any of these pockets to be had?
Healthcare is always a sector in the tax-exempt space in which the spread is wider, even in this ridiculously over-tight market in spreads.
However, tax-exempt healthcare is not completely immune from this trend in equities. The primary culprit for the current tone has some pointing to talk of a single-payer system.
It’s well known that many Democratic candidates who are left of center have been supporters. The dialogue of the single-payer Greek Chorus is essentially triggering a yellow light in the healthcare segment.
Headlines aside, reality of adopting such a system appears remote. Not to mention, free higher education is also being touted simultaneously.
In an era when the U.S. is already facing $1 trillion imbalances in the federal budget, many market observers are simply challenged in seeing how single-payer would be achieved without breaking any fiscal discipline that remains.
Some would say that the way to provide for the program would be to roll back the tax cuts embedded in the Tax Reform. Even if there was some success in reverting to the old tax rates on the personal side, there would be widespread rebellion if there was any serious attempt to roll back on the corporate side. Taxing the 1% crowd has also been suggested but do we really want those folks to emigrate to tax havens?
The primary purpose in raising awareness in the weakness in the equity healthcare sector is to suggest that there eventually may be some spillover into the tax-exempt component. The only challenge is that any weakness that may emerge would be detected very swiftly. In turn, demand would increase apace and there is a better than ever chance the spread would tighten right back up. In addition, the dearth of healthcare supply at only $4.76 billion YTD supports the case.
The backdrop of what happens to Medicare/Medicaid in the days and weeks ahead will influence the outcome.
Recent evaluations have once again suggested that Medicare spending will not be balanced without new Congressional action by as early as 2026. The payroll taxes and other methods that have been adopted are just not standing up to the hordes of Baby Boomers who are expected to be retiring in the not-too-distant future. The focus could easily shift to solving this challenge away from all of the other ones in the healthcare segment.
Of course, the alternative is to trim or to change the Medicare benefits. We have not heard much of this kind of talk since former House Speaker Paul Ryan departed from the scene. Going into this political cycle, we do not think that cutting Medicare benefits is a winning campaign platform. Further, efforts to obliterate the Affordable Care Act have been far from successful.
The bottom line is we may witness some moderate improvements in healthcare benefits that are well short of the goals for a single-payer system. We also may witness some spread widening in the tax-exempt healthcare sector just due to the over-promising of the candidates. In the meantime, the healthcare segment of the market will continue to function just fine.
