Exclusive Interview: Stephanie Larosiliere, Head of Municipal Business Strategies at Invesco
Get an Update on Investor Sentiment on the Muni Bond Market
Ric Edelman: Well, one of the most popular investments for years has been municipal bonds, because Muni bonds are issued by state and local governments, they're often guaranteed by those governments, and the interest is tax free. So what's not to love? And to answer that question, I'm very happy to bring on to the program Stephanie Larosiliere. She is the head of Municipal Business Strategies at Invesco. Stephanie has been with Goldman Sachs, Brown Brothers Harriman, and JPMorgan Chase. Stephanie, I’m really glad to have you on the show with us today.
Stephanie Larosiliere: Thanks, Ric.
Ric: When inflation goes up, interest rates go up. When interest rates go up, bond prices go down. What's been happening in the Muni bond market this year? What do you see, more importantly, happening to Muni bonds for the rest of the year?
Stephanie: So after a record 2021, Muni bond market had $102 billion worth of inflows, we're riding high. Things felt really good, wasn't too much volatility in the market. And when we got to the top of the year, we didn't expect that to change very much. But we were in for a surprise. We had the beginning of an outflow cycle that will be historic. This outflow cycle has surpassed the 2013 Taper Tantrum, 2020 coronavirus, and we're now at about $80 billion worth of funds year-to-date out of Muni mutual funds. And right now it's feeling like we're in a 'steady as she goes' slightly upward movement in terms of Muni momentum. So we're feeling actually pretty good about the second half of 2022.
Ric: So you gave a couple of numbers that I really think are worth highlighting. You said last year there was over $100 billion of inflows into Muni bond funds at Invesco, where investors were very happy with where interest rates were, and they were throwing money into these funds. And then more recently, there's $80 billion of outflows as investors are unhappy. So that's to me a classic buying high and selling low, isn't it? Investors doing the wrong thing at the wrong time for the wrong reason, as usual.
Paying Attention to Key Upgrades of Bond Credit Ratings
Stephanie: Yep, that is exactly what we saw. And so no one paid attention to the increasingly positive fundamentals. Illinois got upgraded by Moody's - got upgraded by S&P for the first time in over 20 years. No one's paying attention to that because they're still stuck on the physiological part of the hierarchy where rates and inflation are just overpowering the system, so much so that the value of Munis is really being overlooked.
Ric: Well, you raise something really important about Illinois getting upgraded. Everybody's focusing on interest rates and interest rate risk. When interest rates go up, bond prices go down. But when it comes to bonds, there's more than just interest rate risk. There's also credit risk. Bonds all get a rating. They get a triple-A rating, double A, single A, triple B, double B, single B, all the way down to D. By the time you're down there, you're in default. Investors don't pay a lot of attention to this, but as a bonds credit rating changes, so does the value of the bond. So talk about that.
Stephanie: We're actually seeing a 3-to-1 upgrade to downgrade ratio. So we're seeing for every one bond that goes down a notch in terms of its credit quality, we're seeing three get upgraded. So when we think about the flow of funds, the flow of capital coming into the municipal market, it actually is unprecedented. It's the most that we've seen since the Muni market's been...you know, we've been keeping record of this. And so what should be happening is the bond prices should be going up because the credit is actually better. However, interest rates, inflation, Ukraine, Russia, all of them, macro concerns have really just overpowered it. And folks have really not been paying attention to the tremendous value that's been built here.
Seeking Stability — and What Investors Now See in Municipal Bonds
Ric: So in other words, your analysis says that on a spreadsheet the Muni bond market is looking pretty good, and prices should be rising. But instead, investor sentiment and psychological attitude is causing the prices to be going down. And this is creating a mismatch in the marketplace 100%.
Stephanie: That's exactly what's taking place.
Ric: So what's it going to take to fix that?
Stephanie: We just need stability at this point. We need inflation to stop taking up interest rates. Going higher, unfortunately, is a necessary evil.
Ric: Well, there are - what is the size of the market now? 70% of all Muni bond buyers are individual investors. And these folks, as you pointed out, do care about their income. They care about safety, and they care about taxes. So ordinarily, you would say, gee, that's wonderful news for municipal bonds. It's a natural audience that wants to buy that product. But the bond market isn't seeing that benefit, as you noted. What's it going to take to turn that around? We have to wait for interest rates to go higher to the point where investors become confident that there aren't going to be any more interest rate increases because at the moment the Fed's made it pretty clear they're going to raise rates another 1% or 2% before the end of the year. So should investors continue to sit on the sidelines or readjust their thinking? What is it investors ought to be doing now regarding Munis?
Stephanie: At this point, it feels like the rest of the Fed moves are priced into the Treasury market, which means they are in turn priced into the Muni market. The one oddball that we can't really figure out is inflation. And if the Fed can tame inflation, I think that will be the catalyst that folks need to be comfortable re-entering the market because at this point, it doesn't matter where you put your money, you're losing 8.6%. You put it under your mattress, it's not $100 anymore. You've lost 8.6% of that. So we definitely believe that it's going to take for inflation to be tamed. We hope that the sentiment of the retail investor shifts. I mean, we know that the retail investor tends to be very emotional in terms of the reactions which results in that buy high, sell low. And we'd love to just make sure that folks know what's happening from a fundamental perspective. And let's not forget that a lot of the tax cuts that were put into the 2017 Tax Cuts and Jobs Act will start to sunset over the next couple of years. So as it relates to taxes, those are not going down. We don't know if they're going up, but we certainly know they aren't going down. So tax exempt income should definitely be more attractive.
Ric: So it really is the time for investors who would ordinarily be thinking about Muni bonds to be getting good, effective advice to determine should you keep the bonds that you've got, should you add more? Should you sell? What is it you should be doing relative to your own circumstances? And there's really no substitute for advice to get information about the Muni bond market and the investments that Invesco offers in municipal bonds. You should go to Invesco.com and you'll get a lot of great information right from them. That's Stephanie Larosiliere here on The Truth About Your Future. Stephanie, thank you so much for joining us on the show today.
Stephanie: Thanks, Ric.