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After a volatile week, munis show resiliency

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      By Cynthia J. ClemsonCo-Director of Municipal Investments, Eaton Vance Management and Craig R. Brandon, CFACo-Director of Municipal Investments, Eaton Vance Management

      Boston - No corner of the capital market has been immune from the coronavirus-induced volatility, and it is now being felt in the municipal market. Volatility has had an impact across the credit spectrum, but has hit the high yield sector especially hard. These developments are starting to open up real value opportunities in the market, especially for organizations with strong credit research like Eaton Vance.

      Last week, we saw 30-year, AAA muni yields increase almost 90 basis points (bps). That is almost as bad as what we experienced during the worst period of the financial crisis. Prior to this selloff, 10-yr. AAA munis were yielding 80% of U.S. Treasuries; now that ratio is in the 150% to 175% range.

      With the US Federal Reserve cutting rates to zero and injecting cash into banks, and the current valuations of munis, we have begun to see banks moving into the sector. We have also seen "retail" trading desks start to move back into munis.

      In high-yield muni ETFs, the damage has been especially noticeable, with liquidity severely impaired. Last week a high-yield muni ETF caused concern in the market with a large bid list and some positions sold at distressed levels due to a lack of liquidity. The selling pressure in HY Muni ETFs persisted throughout the week and as a result we have seen the two largest high-yield muni ETFs trading at discounts of 16% to 19% from their net asset value.

      From a fundamental perspective, most muni issuers are fortunate to be entering this environment in very strong positions. Reserves at the state level, for example, are at the highest they have been in 20 years, although that is likely to erode as data for 2020 starts to emerge. Even states as hard-pressed as Illinois have many levers to raise revenues to meet their obligations.

      At the local level, things are more mixed, but the muni market can show resiliency even in hard hit sectors. Airports, for example, though enplanements will be down sharply in the first half of the year, most airports benefit from fixed rental revenues, which reduces the financial effects of short term travel disruptions. In fact, even though Moody's has downgraded its outlook for airports from "positive," it still views the sector as "stable," even in this period of stress.

      At the strategy level, we've been maintaining our higher-quality bias and, where appropriate, raising cash levels. This gives us the ability to either meet potential redemption requests in an orderly fashion or act on opportunities that arise as the dust settles.

      Our approach has always been characterized by relative value: we find attractive opportunities in weak sectors, and unattractive issues in strong ones. This is an especially important time for strong research capabilities that can comb the market for investment ideas, and we are proud that we have 16 credit investment professionals who are more than up to the task.

      Bottom line: We see munis as a resilient sector that should be opening up many attractive entry points in the coming weeks. Especially for investors in the highest tax brackets, we recommend paying close attention.