January 21, 2020 – In a research report issued today, Morgan Stanley opined that rich valuations for municipal bonds are unlikely to sustain, with “a moderate correction more likely than a substantial sell-off”.

The investment bank recommends investors own shorter duration bonds as the yield curve has flattened and “the cost of waiting” has declined. The analysts led by Michael Zezas also favor taxable bonds over exempts.

Morgan Stanley also highlighted caution on three commonly-held rationales on why investors might still be bullish “despite a historically rich (muni) market”:

1. On the specter of higher taxes, Morgan Stanley opined that unified government is required for any Democratic Party-led tax increases, which “seems unlikely at present”
2. On reduced tax-exempt paper, the analysts felt scarcity is already baked into current valuations. They did not see any evidence that taxable issuance for new money projects are increasing – “the majority of taxable issuance in 2019 was for advance refundings”.
3. Finally, bullish investors have cited continuously strong inflows into municipal asset managers. With mutual funds, close-end funds and ETFS having increased their ownership of the municipal market by 5%, Morgan believes strong inflows might weaken once and when munis rally past intrinsic values.

To obtain a copy of the report titled “Taking Tactical Caution”, contact your Morgan Stanley representative.

Contact Kyle Skinner at KSkinner@buymuni.com.