Muni Market Rebound in First Half

Beth Foos: After a turbulent end to 2016, when municipal bond funds experienced sharp losses and significant outflows in the fourth quarter, the tides turned with the new year.

In the first half of 2017, muni markets rebounded and performance was largely positive, particularly in the high-yield space. For example, the funds in Morningstar's high yield muni category experienced an average return of 4.7% year to date through June 30, outperforming many of Morningstar's other national muni categories, as well as the Bloomberg Barclays Municipal Index and its US Aggregate Bond Index.

Spurring the positive trend were supportive technicals; overall muni bond issuance was down roughly 13% year over year from the robust numbers of 2016, and investor demand continued to grow. At the same time, overall credit quality remains healthy in the muni market despite the stress of several high-profile issuers. The U.S economy remains stable and property valuations have continued to rise in most areas.

Yet negative headlines for some will persist. That includes significant budget stress and unfunded pension liabilities in the states of New Jersey, Connecticut, and Illinois, as well as the city of Chicago and Chicago Public Schools. Also, several entities in Puerto Rico were approved for a bankruptcy-like debt restructuring under federal legislation known as PROMESA in the past several weeks.

As we enter the second half of the year, we'll watch how these issues impact investors as well as outstanding questions around proposed tax reform, which could make munis less attractive when compared to other asset classes, and healthcare reform, which could impact states and local governments as well as hospital providers.