Cumberland Advisors Market Commentary – Cumberland Responds to Barron’s

Three of us have collaborated on this discussion. Our views are pretty much aligned. We think Congress is hobbling an economic recovery by delaying the funding related to COVID-19 and now, additionally, funding related to the wildfires. We think many municipal entities are under extreme stress. And federal help is needed now, or these entities will have to reduce staff, swelling the ranks of the unemployed across the nation and reducing municipal services at the very time that demands for those services are at record levels.

We will identify the author of each part of this collaborative effort.

Cumberland Advisors Market Commentary - Cumberland Responds to Barron's
David R. Kotok writes:

Barron’s has described the $1 trillion funding gap in US states and local governments. Much of that gap is created by or worsened by COVID-19. See “Cities and States Are Facing a $1 Trillion Budget Mess. There Will Be More Trouble Ahead.” Barron’s, https://www.barrons.com/articles/cities-and-states-are-facing-horrific-budget-holes-there-will-be-more-trouble-ahead-51598638702.

So what can be done and how to do it are now key policy questions.

Here are the general outlines of a proposal. The federal government can use its guarantee to back up to a $1 trillion municipal issuance. That would enable worldwide purchases, just as the US federal guarantee enables mortgage lenders like Fannie Mae to issue debt for global market purchases. The federal guarantee also allows the Federal Reserve to purchase such debt and to maintain orderly markets in it.

The debt can be issued by states and their agencies with the guarantee. The debt can be of the self-liquidating type; thus, it is eventually paid back by the states and doesn’t permanently increase the federal deficit. The US Treasury can set rules and the use of funds purposes description. That purpose of issuance can be well-defined (infrastructure, public health, water-sewer, etc.) or left to states’ discretion. Debt type can be inflation-indexed or conventional or zero-coupon or sinking-fund or floating-rate or a mix. The self-liquidating structure is typical in municipal bond issuance and there is no reason to change it. Maturity length can be out to 30 years or even longer. There already is a mature market for long-term Munis.

With the issue, credit pressure on states and their regional and local subdivisions will be buffered, and they will be able to advance and finance the many services that COVID-19 and post-COVID-19 economic recovery will require. We believe the Barron’s estimate of $1 trillion is sufficient to close the funding gap and carry the recovery process for as long as the next two to three years and until the vaccine/treatment issue is resolved with some trust and clarity for the whole population.

We believe that if we want US business to recover and our nation to flourish again, we must get the 90,000 state and local political jurisdictions onto a stable funding platform. The longer we wait, the more difficult a business and economic recovery will be. Now is the time for action. Let me pass this discussion to my colleagues.

Here’s John R. Mousseau on muni markets.

The Barron’s cover story for August 31, 2020, “The Trillion Dollar Hole,” made some good points – the most important being the long-term track record of municipal credit. The article correctly noted that Arkansas was the only state to default on its debt in the Great Depression. What was missing was the fact that Arkansas went that route in order to aid local towns and cities that would have had a harder time recovering on their own, and the decision was made that the state could more easily recover its financial balance than these juridictions could on their own. By the way, Arkansas subsequently cured the default and paid everything it owed to bondholders.

This is not to say that challenges aren’t there for states. We know those – underfunded pension plans, insufficient rainy day funds in many states, and a number of states on the wrong side of “the Laffer curve,” where further tax increases (think combined state income taxes, state sales taxes, and local property taxes) result in a DROP in total revenue to the state, not an increase. For example, New Jersey has been experiencing this phenomenon for several years.

The key for a number of these municipalities and states, and for some troubled issuers is to cut spending to tread water through the remainder of the pandemic and to access the capital markets where available. As we saw with the State of Illinois, as well as with New York MTA in May, issuers may not like the rate that the market affords them, but access has still been robust. Both deals were multiple times oversubscribed; and today, four months later, these bonds still trade well more than 100 basis points lower in yield than they did when they came to market. For example, in May of this year, the State of Illinois (BBB-) had a deal where bonds in 2045 came to market at a 5.85% yield. Those bonds have recently traded at a 3.60% yield to a 10-year call. This happened when the general market had shifted down only about 45 basis points in yield. This is not to say that the market does not back off for more challenged credits. But the market has clearly embraced the federalism we have seen in the wake of the pandemic, whether that takes the form of the Treasury’s special vehicle or the Federal Reserve’s direct purchasing of notes (Illinois and MTA) or the yet-to-be-passed infrastructure program.

The course and tenor of municipal finance changes markedly with the broad distribution of an effective vaccine, though not right away; the changes will be a step function. High-grade credits are already back to pre-pandemic levels, and in the case of shorter-term yields they are well below pre-pandemic levels, because the Fed has cut short-term interest rates. We would expect a general narrowing of credit spreads as a vaccine begins to be accepted and administered nationwide. More-troubled credits such as convention centers, smaller colleges, student housing, airports, transit systems, and sales tax bonds in general should all start to move up on a relative basis.

Also, many municipalities have seen their property tax base increase in value, with COVID-led demand for single-family homes continuing to push housing prices northward along with the pace of sales. So there is room for many local general-obligation bonds to soldier on or perhaps to have a higher tax base. In addition, municipalities are innovative in deriving new revenue sources. Think of a financial transaction tax going to New York City, or of states or counties extracting a “toll” on drones that traverse the airspace above their roads (which the municipalities control). The idea is that lower sales taxes in some areas can be replaced by usage taxes in other areas

We expect to see some creative financing, especially from larger issuers. We know that New Jersey advanced $7–$9 billion in financing. What if you were to sell an inflation-indexed 100-year bond, non-callable, such that the supplemental inflation payment was in the form of tax-exempt coupons. Then have the federal government back the principal of the bonds but the state or city be responsible for the coupon payments and supplemental inflation payments. With thirty-year US Treasury TIPS at a yield of -0.3%, even a troubled issuer like the State of NJ could get away with a real yield of 1–1.5%. For longer-view investors we think that would be attractive as an inflation hedge. It might appeal to pension funds that don’t need the tax exemption.

We know that many of the troubled credits out there (Illinois and New Jersey, even before the pandemic) have a LIQUIDITY issue (a need for cash to pay bills as normal collections are less from sales taxes, ridership revenue for transportation credits, etc.) but not an INSOLVENCY issue. That is an important distinction and one that contributes to the overall extremely good track record of municipal debt. Continued access to the capital markets, combined with realistic choices and belt tightening, should pave the way for better days for municipal issuers and for the market as the economy comes back.

Here’s Patty Healy on how a federal backing that raised $1 trillion would help the existing $4 trillion municipal finance sector to stabilize and would lower borrowing costs for most jurisdictions in the United States.

State and local municipalities received $150 billion in CARES Act funds, and the action was swift, delivering aid to the hardest-hit sectors and to states and large municipalities. Presumably, the state funds could be downstreamed to localities. The funds, however, were not without strings and could be used only for COVID-related expenses, not for revenue replacement, though revenues had plummeted dramatically. Other programs were designed to help businesses retain employees, and unemployment benefits were increased so that bills could be paid and some level of consumption could continue as the economy shut down to battle the pandemic.

Municipalities, which are on the forefront of addressing the pandemic, having seen a substantial drop in revenues, have had to cut budgets and personnel and in some cases reduce planned capital expenditures. Some may not even make the annual payments required to keep their pension funding levels from decreasing. If they don’t, pension funding becomes more expensive in the longer run – a vicious cycle that has caused the loss of financial flexibility for some and credit downgrades for others. Higher leverage and credit downgrades do increase borrowing costs.

According to the Bureau of Labor Statistics, state and local public employees make up approximately 13% of the American workforce, with municipalities alone employing nearly three million people nationwide. The Center on Budget and Policy Priorities noted that total nonfarm payroll employment (private plus government) fell by 22 million jobs in March and April, wiping out a decade of job growth. Despite job growth since then, including 1.0 million jobs added in August, private payroll employment remains 10.7 million jobs below its February level while state and local government payrolls remain 1.1 million jobs below their February level. The history of the financial crisis showed that the loss of municipal employment was a drag on the economy and lengthened time to recovery.

Congress has been dragging its feet in providing additional aid to municipalities, and many hope some aid will arrive shortly; otherwise, budget cuts will continue, services will be reduced, and the recovery will be slowed. The Center estimates that states, excluding local governments, need $555 billion, with the shortfall expected through fiscal 2022. If municipalities could plan on some aid, even phased-in aid; and if funds are not immediately available, at least budgets could take into consideration additional future aid and minimize the number of layoffs and service reductions.

Any mechanism to get needed funds to state and local governments – and soon – would help retain state and local public employees. A guarantee fund could be useful, lowering funding costs for municipalities close to the cost of Treasury bonds. The September 16, 30-year Treasury bond yielded 1.45% at the end of the day (Sept 16), while AAA-rated municipal bonds yielded 1.72%; the 10-year was at 0.67% compared with AAA yields of 1.16%. Shorter-term yields recognize the short-term risks that the market perceives in the municipal market. Debt repayment could be stretched out so that the additional debt-servicing burden would be minimal. Already a number of issuers are refinancing higher-cost debt and in the process reducing the amount of near-term maturities. They are also extending the final maturity of the bond, a move called “scoop and toss” in Muniland. While in good economic times scoop and toss is a signal of stress at a municipality that opts to do it, during an extreme situation it becomes a tool for the municipality to manage through the crisis.

Bottom line from our three authors: We are not in business-as-usual financial times. State and local governments need help, and the federal government has the ability to help them. The time for that action is now.

David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio


Virtual Event Thursday, Sept 24

Cumberland Advisors is an Annual Sponsor of

the Global Interdependence Center

GIC - Monetary Policy with James Bullard, Ph.D.

GIC’s next Executive Briefing will explore monetary policy with James Bullard, Ph.D., President & CEO of the Federal Reserve Bank of St. Louis. Join them Thurs, September 24 at 12:00 p.m. ET.
Complimentary registration: https://bit.ly/33DvgLX


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Cumberland Advisors Market Commentary – The Rise of Separately Managed Accounts – 2020 Update

Cumberland has utilized separately managed accounts (SMAs) to execute its fixed-income strategy since the company’s inception in 1973, long before SMAs were popularized in the early 2000s.

Cumberland Advisors Market Commentary - Separately Managed Accounts - (Patricia Healy)

The reasons for managing money in this fashion are the same today as they were then:

• Transparency (you know what you own)

• Flexibility to make strategic changes

• Ability to manage transaction costs and best execution

• Active management

SMAs offer individually catered management of clients’ objectives, including tax management, income production, state-specific needs, cash flow-specific needs, and ability to institute investment restrictions.

What exactly is an SMA? Per Investopedia: “A[n] SMA is a portfolio of assets managed by a professional investment firm. In the United States, the vast majority of such firms are called registered investment advisors and operate under the regulatory auspices of the Investment Advisors Act of 1940 and the purview of the US Securities and Exchange Commission (SEC). One or more portfolio managers are responsible for day-to-day investment decisions, supported by a team of analysts, operations and administrative staff. SMAs differ from pooled vehicles like mutual funds in that each portfolio is unique to a single account (hence the name). In other words, if you set up a separate account with Money Manager X, then Manager X has the discretion to make decisions for this account that may be different from decisions made for other accounts.”

Many of the elements of this update are the same as last year’s, because the benefits of SMAs remain; however, the markets, technology, and regulation are always changing, which can affect supply, cost of execution, and relationships to other markets. New areas discussed this year are the effects of the pandemic and political responses to it on securities, as well as the prospects for inflation

The Cumberland Approach

At Cumberland we have a top-down approach to investment management. We look at global macroeconomic conditions and policies to assess interest rates and growth prospects and position our portfolios accordingly. Each market and/or sector is evaluated as to how it fits in the global outlook as well as how its idiosyncratic elements may affect supply and credit quality.

The majority of our fixed-income portfolios are managed on a total-return basis using a barbell strategy to more quickly take advantage of changes in interest-rate and technical changes. In a total-return account, the return is measured against a benchmark, which is usually an index that is widely recognized. Outperformance may mean that individual portfolio returns are less negative than the benchmark’s, or that positive returns are greater than the benchmark’s.

Fixed-income total-return investing takes into consideration price appreciation or depreciation and the effects of coupon income generated and reinvested. Coupon payments over time are a large contributor to the return of an account, but the timing of buying and selling and where along the curve to buy or sell can greatly impact returns. Other buy-sell considerations include duration, or the sensitivity of a bond to changes in interest rates, embedded options such as call features, supply and demand, coupon structure, and credit-quality trends. All of these can affect the performance of a portfolio relative to an index or benchmark. Finally, to quote Cumberland’s John Mousseau, “Active management means active thinking, not always active trading.”

Oil Prices and the Pandemic

There was a double whammy to markets in early March. First came a drop in oil prices, followed by the precautionary shutdown of the economy due to the COVID-19 pandemic. Treasury markets rallied as investors sought safety, while other asset classes tanked. On March 24th municipal bonds were yielding 2.52% to 3.37% at ratios of 6.8 to 2.4 times that of comparable Treasury bonds (bonds with the same maturity). At Cumberland we had already become more defensive because rates had gotten so low, and we had already upgraded the credit quality of our portfolios because credit spreads were so narrow. See https://www.cumber.com/the-muni-selloff-that-was/.

The selloff presented opportunities. As funds were selling due to investor redemptions, we were buying long-dated municipal bonds at extremely cheap rates. Our barbell structure allowed us to do this, and many of our shorter-dated bonds were pre-refunded, meaning they were backed by Treasury securities structured to match the cashflow of the bonds to the call date – thus they were very liquid, providing funds for the purchase of the longer-dated, higher-yielding paper.

Subsequently the Federal fiscal and market response (see “The Fed and Markets,” by Bob Eisenbeis, https://www.cumber.com/cumberland-advisors-market-commentary-the-fed-and-markets/, and “Where Are Munis Getting Their Money?” by Patricia Healy, https://www.cumber.com/cumberland-advisors-market-commentary-where-are-munis-getting-their-money/) allayed investor fears and market conditions reversed. Bond prices rose, and the stock market has rallied. The stimulus applied by the Fed to ease economic fallout from the pandemic has increased the prospect for higher tax rates in the future, so municipal bonds have been in high demand. Munis have also been boosted by their higher average credit quality compared with corporate bonds.

Cumberland has been able to take advantage of oversold situations during past times of stress such as the Meredith Whitney incident (2010), the “taper tantrum” (2013), President Trump’s election (2016), and the excess supply at the end of 2017. Subsequent to the dislocation in early March, there was a “Meredith Whitney moment” when Mitch McConnell suggested some municipalities should go bankrupt – handing us an additional buying opportunity. See John Mousseau’s commentary “McConnell as Meredith Whitney”: https://www.cumber.com/cumberland-advisors-market-commentary-mcconnell-as-meredith-whitney/.

See also John Mousseau’s discussion for Oxford University, “Bond Markets Through the Virus”: https://youtu.be/YSBGibTMK4o.

The ongoing pandemic and the government’s reluctance to give direct aid to municipalities could cause some credit events or at least generate negative headlines that could spook conservative municipal bond investors; and strong outflows from funds, lowering prices, could present another buying opportunity; thus we are currently moving to more intermediate securities.

Inflation?

Could inflation rear its head with all the stimulus that has been pumped into the economy and with the Fed signaling that it could withstand periods of higher rates to compensate for periods where inflation has been under the 2% target? Bob Eisenbeis discusses some scholarly papers on the topic here: https://www.cumber.com/cumberland-advisors-market-commentary-inflation/, and David Kotok discusses the experience of France and inflation after a pandemic here: https://www.cumber.com/cumberland-advisors-market-commentary-inflation-coming-maybe-maybe-not/.

(To be added to our distribution list, go to cumber.com and sign up or send an email to me at patricia.healy@cumber.com.)

Decades-Long Rate Rally

We have been in a 39-year rally in the bond market, and yields continue to decline in the worldwide trend to zero and even negative rates; but if you don’t pay attention to points of entry and the other details, you can miss out on performance. Similarly, in an increasing interest-rate environment – which may be upon us, given the potential for inflation from accommodative easing – points of entry and exit can affect performance. The use of a barbell strategy allows us to invest in various short-term instruments that are liquid and to use them as ammunition to buy longer-dated bonds when interest rates rise or to take advantage of the higher coupons of longer-maturity bonds compared with shorter-dated bonds. Floating-rate notes and inflation-protected securities are investments that can help returns in the face of inflation and rising interest rates.

We are addressing municipal assets in this commentary; however, we also manage taxable fixed-income, equity, and balanced accounts. In managing equity accounts, we utilize exchange-traded funds (ETFs) and actively conduct sector rotation. Exchange-traded funds allow more flexibility and generally lower total trading costs than individual-stock portfolios do, and they avoid sales and purchases that mutual funds must make due to funds flows. We will consider using fixed-income ETFs in smaller balanced accounts to get the benefit of diversification.

The advantages of SMAs have led to their increased use by investors. According to Citi Research, SMA municipal fixed-income assets, both taxable and tax-exempt, have grown from $100 billion in 2008 to $683 billion at the end of Q4 2019, with holdings expected to reach $704 billion in Q4 2020. The details are not separately reported by the Federal Reserve, so Citi Research uses a quarterly survey of its customers and certain Federal Reserve flow of funds data to arrive at an estimate. Note that the rate of growth of SMA municipal assets has been greater than growth in direct retail and mutual fund municipal assets – but pay attention to the scale. For example, direct retail is still almost double SMA assets.

As discussed earlier, mutual fund performance is affected by fund flows and herd mentality and thus presents opportunities for active fixed-income management. When investors are dumping assets, the mutual fund portfolio manager may not be able to fully practice active management and must liquidate funds as required by redemptions. In these cases, the most liquid and generally higher-quality assets may be sold first in order to minimize effects on net asset value (NAV). Alternatively, when assets are pouring into mutual funds, the increased demand for assets results in higher prices and can present a selling opportunity for SMA managers.

Supply and demand can have an effect on bond performance. The currently low municipal supply is partly due to changes in the Tax Cut and Jobs Act that no longer allow municipalities to refinance certain bonds, as well as to high demand from investors in high-tax states and “cross-over” buyers that have become more familiar with the US municipal bond market. Municipal bonds in general have higher ratings than and less correlation to corporate bonds, as well as higher yields compared to other worldwide offerings. The supply of municipal bonds may increase as budgets are passed and issuers engage in deficit financing.

At Cumberland we buy bonds in large lots and allocate positions to individual portfolios, which allows for better execution and pricing for our clients compared with doing individual trades for each client.

Retail accounts do not enjoy the economies of scale that are available to an SMA manager. In addition, active SMA managers that practice total-return investing may have credit-research resources and relationships with many broker dealers that allow them to achieve competitive execution and develop strategies to optimize investment holdings to meet individual clients’ needs.

While mutual fund shares can be purchased and sold any day in any amount, an SMA account has many individual holdings that may take longer to sell. However, when an investor sells shares in a mutual fund, the price received is calculated at the end of the day, based on the net asset value of the fund. If an investor is instead invested in high-quality liquid bonds like the ones Cumberland purchases in its accounts, then barring an extraordinary event in the market, there should be ample liquidity and the bonds will be sold at a time that maximizes price. Additionally, knowledge of our clients’ needs has Cumberland looking ahead to provide liquidity when needed. SMAs can also give every client the advantage of providing the portfolio manager with sectors or categories, such as “green” or “ESG,” to be excluded or included. Customization is not possible with a mutual fund.

Separately managed accounts generally have higher minimum investment requirements than mutual funds or roboadvisors do, so they are not available to all investors. But as an investor acquires more assets and develops more highly tailored goals and objectives, an SMA may be appropriate.

Finally, the management fee charged on SMA accounts can be affected by the competitive environment. The fee is based on the type of strategy and can be scaled based on the level of assets invested. There may also be custodial fees charged to the account. Mutual funds have an expense ratio, which includes a management fee as well as miscellaneous ancillary expenses, custodial expenses, and a distribution charge. Many have various levels of sales charges. So it is important to look at all expenses when comparing funds.

At Cumberland we continue to operate as our founders did, investing clients’ funds in separately managed accounts. Our approach to investing is top-down and takes account of global interest-rate expectations and credit-quality trends. Accounts are actively managed with a total-return or income orientation, depending on clients’ needs.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




BondBuyer – Florida preps $2.25 billion deal to pay hurricane insurance claims

Excerpt below.

By Shelly Sigo – The Bond Buyer
August 31, 2020

Cumberland-Advisors-Patricia-Healy-In-The-News

Florida plans to “opportunistically” take advantage of historically low taxable municipal bond rates in a $2.25 billion deal that a state official said should be attractive for yield-starved investors.

Proceeds will provide capital to pay claims, if needed, by the Florida Hurricane Catastrophe Fund, a state-run, tax-exempt trust fund that provides lower cost reinsurance to the private property insurance market, and the state-owned Citizens Property Insurance Corp., an insurer of last resort for homeowners.

The bonds are rated AA by Fitch Ratings and S&P Global Ratings, and Aa3 by Moody’s Investors Service. All assign stable outlooks.

Sarasota, Florida-headquartered Cumberland Advisors, an investment advisory firm with over $3 billion in assets, has purchased the corporation’s bonds in the past, said Patricia Healy, senior vice president of research and portfolio manager.

Cumberland may be interested in buying some of the bonds being sold this week, she said.

“It would depend on final pricing because it always comes down to that and where it falls out relative to other structures,” Healy said. “We’re fine with the credit [but] it could come rich.”

Healy also said “it’s kind of funny” that the bonds are being issued during hurricane season, which runs from June 1 through Nov. 30.

Read the full article with subscription (paywall) at The Bond Buyer website.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Cumberland Advisors Market Commentary – Hurricanes

In the Indian Ocean they are called cyclones, in the Pacific Ocean, typhoons. The latter term comes from the Chinese tai fung, which translates as “great wind.” The Kʼicheʼ Mayans called their god of wind, storm, and fire Hurakan. European colonists adopted the word, and it became hurricane. (Source: A Furious Sky: The Five-Hundred-Year History of America’s Hurricanes, by Eric Jay Dolin, https://www.amazon.com/dp/B07ZTTHPB8/. This marvelous book, recommended by John Mousseau and me, covers 500 years of hurricane history.)

David R. Kotok

American history buffs will relish the story about the very first European settlements in the present-day United States – not Plymouth, MA, or Jamestown, VA, but a half century earlier at Fort Caroline (now Jacksonville) and St. Augustine. There is also the 16th-century history about how a September hurricane was the determining factor in a Spanish victory over the French. Jamestown wasn’t spared when a hurricane disrupted supply lines from England in 1608. Plymouth got hit, too, on August 15, 1635.

 

Hurricanes mean credit risk, property risk, and physical risk. They also lead to rebuilding and new growth. They are economic factors and investment market factors, and these days they are political factors as voters determine civic readiness and emergency aid deployment. In sum, hurricanes are a big deal. Because the Gulf of Mexico is so hot now relative to previous decades, Laura, which has barreled through Louisiana and Texas, causing extensive damage, is a very big deal — bigger than the storm would have been in a cooler Gulf. And that means the climate change debate heats up further; and it, too, is a big deal. 

 

We will leave this political debate aside, having had a lot of it in the last two weeks and anticipating a massive amount more in the next two months. 

 

Cumberland has focused a lot on hurricanes and on their credit impacts involving state and local governments’ municipal bonds. We have an internal review system of those credits, and we consider hurricane and other natural disaster risks as part of the muni management function.

 

Here’s our most recent piece that discusses muni credit and hurricanes: “Managing Hurricane Risk in a Bond Portfolio,” https://www.cumber.com/cumberland-advisors-market-commentary-managing-hurricane-risk-in-a-bond-portfolio/, by John Mousseau and Patricia Healy.

 

And here are a number of links to our earlier hurricane missives. We decided to list a few of them for readers who might then be able to draw some inferences about hurricane risk management and munis. You might enjoy the one about “domino” effects.

 

“Katrina,” September 1, 2005; https://web.archive.org/web/20061024101825/http:/www.cumber.com/commentary.aspx?file=090105.asp&n=l_mc. A summary of Cumberland’s portfolio strategy in response to Hurricane Katrina, written by David Kotok. Commentary on each asset class is included, by John Mousseau (tax-free municipal bonds), Peter Demirali (taxable bonds), and Matt Forester (exchange-traded funds).

 

“Katrina Bonds: Tax-free Municipal Dominoes??” David Kotok, September 4, 2005; https://web.archive.org/web/20061024101244/http:/www.cumber.com/commentary.aspx?file=090405.asp&n=l_mc. A case study of potential Katrina muni dominoes. Also summarizes Cumberland’s muni bond management actions taken in response to Katrina.

 

“Does Katrina = Fed to Full Stop?” David Kotok, September 7, 2005; https://web.archive.org/web/20061024102518/http:/www.cumber.com/commentary.aspx?file=090705.asp&n=l_mc. Advances the argument that Katrina could lead to a full recession and not just a few months of slowdown.

  

“Looking Irma in the Eye,” David Kotok, September 10, 2017; https://www.cumber.com/looking-irma-in-the-eye/. A personal account of meeting Irma head-on in Sarasota.

 

“Key West,” Bob Bunting, November 21, 2017; https://www.cumber.com/key-west-bob-bunting/. Guest commentary by Bob Bunting. Reports on a fact-finding trip to Key West and five other Keys that were hit by Hurricane Irma.

 

“It’s Hot and Getting Hotter – The Case for Adaptive Strategies for a Warming Planet,” Bob Bunting, August 29, 2018; https://www.cumber.com/guest-commentary-by-bob-bunting-its-getting-hotter/. Guest commentary by Bob Bunting, professor and meteorologist for both NOAA and the National Center for Atmospheric Research.

 

“Is Climate Warming Creating More Dangerous Hurricanes?” Bob Bunting, December 21, 2018; https://www.cumber.com/is-climate-warming-creating-more-dangerous-hurricanes/. Guest commentary by Bob Bunting.

 

Recorded livestream of the January 25, 2019, Climate Change Summit at the University South Florida Sarasota-Manatee, https://buff.ly/2WgFkWU. Patricia Healy speaks on how municipal bond ratings are affected by the preparedness of the issuers for severe weather events, the impacts of climate change, and other factors that may affect credit ratings.

 

In the risk-management business there are specialized research services that actually break down natural-disaster exposure by the CUSIP identifier on a municipal bond. Here is the risQ website, where you can get a sense of the nature of the service: https://www.risq.io/. By the way, it works for California wildfires, too. 

 

Laura is this season’s version of the Mexico Beach wipeout that hit Florida in 2018 or the Waveland, Mississippi, disaster in 2005. In our view the destruction from hurricanes will only worsen over time as sea levels rise and temperatures climb. 

 

Climate change is real. Just visit one of the places hit by a hurricane shock and judge for yourself. I have

David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio

Adapting to a Changing Climate – Global to Local Impact

From hurricanes to red tide and sea level rise, learn how a changing climate affects the Sarasota-Manatee region and the state of Florida. Speakers discuss the challenges and impact on Florida and other coastal communities while uncovering the adaptive strategies that bring unique social and economic opportunities.

Climate Change Summit 2019 USFSM

Watch the Climate Change Summit here: https://buff.ly/2WgFkWU




Cumberland Advisors Market Commentary – Managing Hurricane Risk in a Bond Portfolio

The Northeast continues to clean up from Hurricane Isaias, which swept up the Atlantic coast to New York and parts of New England on Thursday.

Below is a slide from a presentation by our good friend Tom Doe, who heads up Municipal Market Advisors (http://www.mma-research.com). Tom’s firm does in-depth quantitative and qualitative research on the muni market, and we show the slide with their permission.

As you can see from the slide, hurricane season is upon us, and some observers think it could be the busiest storm season since 1851. The hurricane risk forecast is very high this year (some say the highest ever), and water temperatures in the Atlantic and Gulf are setting records. Not only that, but as we have witnessed, storms are lingering longer, traveling farther, and dropping more rain, causing major flood damage in addition to wind damage. It is not just the coastal regions that are impacted, either, as we have seen the Midwest and inland South also sustain more damage in recent years. States, municipalities, and first responders have been proactive in preparing; and now we have the added complications of the coronavirus pandemic and how to manage evacuations and sheltering while still maintaining social distancing and other safe practices.

At Cumberland we track hurricane cones of uncertainty five days before landfall to determine if any of our municipal bond holdings could be negatively affected by the storm, and we act early to exit those holdings that are in the path of a storm. We did this ahead of Hurricane Katrina in August of 2005, exiting many of our Gulf Coast holdings, and we have employed this strategy for many subsequent storms. The key is not to be precise meteorologists but to do smart risk assessment. In the case of Katrina this meant selling selected credits stretching along the Gulf of Mexico from Galveston, Texas, across the Louisiana, Mississippi, and Alabama shorelines, all the way to the Florida Panhandle.

The selection of credits to sell involves looking at exposure (read, close to the coast) and size (Galveston general-obligation bonds: sell; Harris County (Houston) toll roads: keep). The idea is that by being proactive, credits with potential exposure can be sold, and bonds with similar ratings in different geographic areas can be bought, thus not disturbing duration, yield, and maturity considerations in a portfolio but reducing event-specific risk. In the case of Katrina, none of the credits we sold were terribly affected, with the one major exception of New Orleans bonds (water, airport, etc.). Today these credits continue to be backed by vibrant municipal entities, but at the time the HEADLINE RISK post-Katrina rendered many of the bonds illiquid. Did they come back? Yes, but it took a while.

What have we learned since Katrina?

In 2005, we didn’t have the interactive maps and online meteorological tools we have now. We did it the old-fashioned way, with a list of credits, push pins, and a Rand McNally map of the Gulf. Katrina was the biggest hurricane to hit the US in a century. As a practice, if two bonds from a state were similar in yield, credit, maturity, etc., we opted for the bond away from the coast. All other things being equal, we would rather own the bond of Columbia, SC, that is backed by the University of South Carolina than a limited-tax general-obligation pledge from Beaufort, SC, which is right on the coast.

There’s no magic number, but 100 miles from a coast is a good place to draw the line. And the essentiality of a service also factors into judgments. A water or sewer bond covers the type of service that will have priority getting back online (thus earning debt service).

Fifteen years after Katrina, we feel we are in a much better position to manage through strong hurricanes because of our bond selection method. Does that mean we avoid coastal credits totally? No. Yield on a bond is still important; but, in our view, if we are to assume that larger geographical/meteorological risk, we need to get paid for it.

And as we enter the heart of hurricane season, we continue to be vigilant on credits from the Gulf to the Carolinas, and from the Middle Atlantic to New England. And for all the benefits that Google Maps brings to our work, we still have multiple copies of the Rand McNally atlas, for that day when a Cat 4 barrels down on us.

Stay safe and enjoy the rest of the summer.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
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Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio

With contributions by Amy Raymond
Fixed Income Dept. Manager


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – Why States Are Not Going to Default from the Coronavirus Fallout

In our opinion this is a short-term shock, although it will likely change some behaviors for the long term that will need to be monitored.

Market Commentary - Cumberland Advisors - Why States Are Not Going to Default from the Coronavirus Fallout

The initial concern is liquidity, not just in the bond market but also at the state level, where tax payment dates have been extended and economically sensitive revenues such as sales taxes, energy taxes, and transportation fees have experienced a sharp drop-off from the coronavirus-induced shutdown. The unprecedented federal response is to address liquidity in the market as well as provide funds to important sectors of the economy such as healthcare and transportation and other aid to municipalities for fighting the virus. Postponed revenues will eventually be received by the states, although not as much as states had originally budgeted.

States have tremendous resources available to them, and numerous states have economies larger than the GDP of some countries. Resources include federal aid revenue sharing, taxing, and fee-raising ability. States also have the flexibility to reduce expenditures. Many states budget conservatively to have flexibility to adjust revenues and expenses throughout the year. Most states have also built up sizable reserves as a reaction to their experience during the financial crisis. I just got off a conference call with Fitch Ratings, whose analysts surveyed states and reported that many are expecting to use internal fund borrowing to finance the delay and shortfall in revenue. They also have tremendous market access and access to their banking partners.

States are not authorized to go bankrupt. States cannot file for Chapter 9 bankruptcy, because they are co-sovereigns with the federal government under the US Constitution (10th Amendment). The State of Arkansas did default on payments during the Depression because of the desperate economy and their overlevered position, but the state eventually repaid the debt.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – COVID-19 and Municipal Credit Quality

Until recently it was unclear if the new coronavirus would reach the United states. Now we have 88 reported cases in the US, at least two without a clear connection to travel to China, and as of Sunday night two deaths; so we feel it is time to comment on the ability of US municipalities to withstand financial dislocations resulting from the virus. Please see https://cumber.com/category/market-commentary/ for numerous commentaries by David Kotok on COVID-19 and other virus-related discussions.

Market Commentary - Cumberland Advisors - COVID-19 and Municipal Credit Quality

Municipal credit quality continued to improve through the third quarter of 2019, per Moody’s and S&P, with upgrades still more prevalent than downgrades; and from our observations it seems that trend is persisting. One of the reasons for continued upgrades is the growth of rainy-day funds, or set-aside reserves. These balances can counter an unexpected decline in revenues from a reduction in employment or economic activity (think faltering income tax and sales tax revenue) or shocks to expenses (a bad snowstorm or other natural disaster). At the same time, corporate bond credit quality has drifted lower; and, as many economic pundits have opined, a shock from the virus could reduce employment in the US as supply chains are disrupted, consumers pull back on spending, and corporations reduce hiring. To the extent that these impacts materialize, they will affect the level of income and sales taxes that help fund municipal operations.

If the virus follows a SARS or MERS or flu trajectory, the economic dislocation should not last long, and economic conditions would likely rebound, with pent-up demand for certain products and services reversing the slowdown to some extent. An extended dislocation and decline in economic growth could cause reductions in financial flexibility, though we have a long way to go on that front, with the national unemployment rate at a low 3.5%. (See John Mousseau discuss current market conditions with Suncoast News here: https://www.cumber.com/cumberland-advisors-president-ceo-discusses-worst-week-on-wall-street-since-2008-financial-crisis/.)

As the virus takes hold in the US, federal and state aid to municipal health providers would also be expected to improve preparedness around the country and could help soften the blow to rainy day funds.

The healthy reserves of many states and cities are why we think municipalities are well positioned to weather some economic dislocation. We have mentioned numerous times that this build-up of reserves is a function of the memory of dislocations from the financial crisis. The drawdown of reserves to counter lower revenue growth would likely be met with expense reductions as well. The drawdown of reserves, in and of itself, should not result in a ratings downgrade, because a municipality should not be penalized for using a rainy day fund for its intended purpose. However, a municipality that continues to draw down reserves without a stated plan to replenish them may be subject to a downgrade if corrective action is not taken.

Other sectors of the municipal market, such as state housing agencies, utilities, airports, and toll roads, have also improved as a result of good growth and improved financial operations. Granted, there are municipalities that have been downgraded due to increases in debt, reductions in state aid, population declines, and poor pension funding, among other reasons. Consequently, it is important to differentiate among credits when investing.

What about our US healthcare system? How well are our municipal or not-for-profit healthcare systems and standalone hospitals financially prepared to cope with the virus? Municipal healthcare-related bonds are issued mostly by not-for-profit healthcare systems that have been growing and diversifying by acquisition and new construction projects. They are generally large and have been diversifying both geographically and with respect to product delivery (by providing insurance or acquiring doctor groups, for instance), all while trying to keep ahead of ever-mounting patient-information regulatory and technological requirements. Many of these systems have national or regional service areas, adding to diversification.

The rating or credit quality of the healthcare sector has been mixed, with some systems experiencing upgrades as acquisitions add to diversification and a better competitive position, and some systems experiencing downgrades because of increasing leverage and/or having become too large and thus more difficult to manage. There are also standalone hospitals in urban settings and rural areas, and the bonds issued for these institutions are sometimes secured by a general-obligation pledge of a municipality as well as by net hospital revenues.

We expect the effects of the pandemic to be uneven. Urban settings may have more resources to fight a pandemic; however, since more travelers pass through densely populated urban areas, the virus could be brought in and spread more rapidly. Conversely, a rural hospital may have little transmission in its service area, but does it have the resources to confront a viral breakout if one occurs? In a pandemic there would likely be a surge in virus treatment at the expense of higher-paying surgical procedures. An important metric to consider when evaluating healthcare credit is number of days of cash on hand. Many higher-rated credits have in excess of a year’s worth of cash to cover expenses, as well as investments whose value exceeds outstanding debt.

It is comforting, to some extent, to be hearing more news about preparedness efforts at states and cities, hospitals, and businesses. The Wall Street Journal had a comprehensive article today on US hospital preparedness: https://www.wsj.com/articles/widespread-coronavirus-cases-could-tax-u-s-hospitals-11582920055. At Cumberland Advisors, our business continuity plan has gone into place as we assess the ability of our employees to work remotely, and we have encouraged folks to stock up on nonperishables. Our location in coastal Sarasota, FL, has many of us conditioned to being prepared for disasters such as hurricanes.

The spread of the virus worldwide, travel bans, and self-imposed reductions in travel will likely affect airports. Airports in the US have various types of contracts with airlines, some that insulate the airport from declines in traffic, some that are are based on traffic, and others that have elements of both. Airports with contacts based on traffic generally have strong debt service coverage and liquidity. Ports have contracts with shippers, which generally include minimum obligatory payments. Enplanements at airports and tonnage through ports are leading indicators for the health of these systems regardless of the contracts and should be monitored for changes and for management’s response to changes in traffic.

At Cumberland Advisors, we are attuned to current developments and keenly aware of past history regarding epidemics and pandemics and the effects they can have on various sectors of the economy and on municipal credits. We will continue to take developments with regard to COVID-19 into careful consideration in our investment decision-making.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio


Upcoming event with Cumberland Advisors that features a panel with Patricia Healy…

Join Cumberland Advisors on Friday, March 20, 2020 for a program called “An Outlook on Energy Policy“. The event is held in partnership with the Global Interdependence Center, the University of South Florida Sarasota-Manatee, and with support from the Alliance for Market Solutions and First Trust. This half-day conference will explore investing in energy, policy approaches to climate change, and energy’s effect on Fed policy. “An Outlook on Energy Policy” will feature Danielle DiMartino Booth, CEO & Chief Strategist for Quill Intelligence LLC, Samuel Rines, Chief Economist, Avalon Advisors, Jim Lucier, Capital Alpha Partners, Former Congresswoman Gwen Graham, Former Congressman Carlos Curbelo, Jim Slutz, Director of Study Operations at the National Petroleum Council, along with other speakers and moderators.

More information and speaker bios can be found at the Global Interdependence Center website: https://www.interdependence.org/events/an-outlook-on-energy-policy/

We look forward to sharing with you an event filled with conversation, thought leadership, and valuable information.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Market Commentary: Puerto Rico Earthquakes – Insult to Injury

For the people of Puerto Rico, natural disasters have become all too commonplace. Two years ago there was Hurricane Maria, which claimed thousands of lives and caused billions in damages.

Market Commentary Puerto Rico

Now the island has experienced a series of earthquakes (the largest being a magnitude 6.4), which have again caused destruction and again brought fear and uncertainty. Our hearts go out to the people of Puerto Rico, our fellow Americans. The devastation hits especially close to home for Cumberland as many of our employees have family that call the island their home.

Governor Wanda Vazquez has declared a state of emergency. Total damage estimates remain uncertain at this point, though the damage is likely much more limited than the devastation Maria caused. The initial damage estimate of $110 million was made after the magnitude 6.4 quake that shook the island on Tuesday, January 7th, but before the 5.9 quake that followed on Saturday, January 11th, along with numerous other aftershocks. Time will tell the longer term damages to the island’s economy and future.

According to FEMA, President Trump has approved an emergency declaration, allowing direct federal assistance for emergency measures to protect lives, property, and public health. The Commonwealth awaits a major disaster declaration from the president. Federal dollars will likely flow to the Commonwealth to rebuild what has been damaged or destroyed. The rebuilding that occurs after a disaster and the flow of federal dollars, insurance proceeds, and additional workers generally boosts the economic activity of an area. That expectation is being borne out by the better-than-expected revenues the Commonwealth has clocked post Maria. The resilient folks on the island will move forward together and find ways to adapt.

Power and water have been restored to many, but the systems remain fragile, and power in some areas was lost again after Saturday’s 5.9 quake. The United States Geological Survey (USGS) is forecasting a 68% probability of a magnitude 5.0 earthquake in the coming week, with aftershocks to continue, at a decreasing frequency, for the next 30 days. So the island isn’t out of the woods yet.

For Cumberland’s Insured Puerto Rico Strategy the earthquakes are less significant. To note that fact is not to downplay the damage to both people and property. Our strategy depends on the financial health of carefully selected municipal insurers. In particular, Assured Guaranty has significant claims-paying resources and is proactive in its approach to managing its book of business, including its exposure to Puerto Rico. We continue to believe the insurers utilized in the strategy remain sufficiently capitalized and able to pay principal and interest when due.

Patricia M. Healy, CFA
Senior Vice President of Research & Portfolio Manager

Shaun Burgess
Portfolio Manager & Fixed Income Analyst


Upcoming Virtual Event

Is Productivity Growth Dead?
Structural and Cyclical Factors Impacting Growth Discussed

David Kotok invites you to join the Global Interdependence Center for a live Virtual Event webcast that will explore why labor productivity is so weak and what policy and economic factors are likely to impact future productivity growth.

Date: Thursday, January 23, 2020 Time: 12:00 PM – 12:30 PM

GIC welcomes Jeffrey Korzenik, Chief Investment Strategist & Senior Vice President, Fifth Third Bank, and Donald Rissmiller, Founding Partner of Strategas and GIC Chairman Emeritus, who will offer their insights on this important economic topic. The call will be moderated by Bill Kennedy, GIC Vice Chair of Programs.

The audio for this virtual event will be conducted via the web and telephone dial-in from 12:00 p.m. Eastern/9:00 a.m. Pacific/5:00 p.m. London. Q&A and presentation materials will be made available during the call via the web. Dial-in information will be distributed via email in the days leading up to the event.

Speakers:
Global Interdependence Center live Virtual Event: Is Productivity Growth Dead?

Complimentary Registration: https://www.interdependence.org/events/is-productivity-growth-dead/


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Cumberland Advisors Market Commentary – 4Q 2019 Credit Commentary

Pensions, budgets, state ratings, climate adaptation, cybersecurity, and investing

 

Market Commentary - Cumberland Advisors - Q4 2019 Municipal Credit Commentary

This fourth-quarter commentary continues discussion on key themes of the year. Many of the themes are long-term in nature and reveal the need for governments and businesses to continue to evolve. Pensions, cybersecurity, climate resiliency, evolving demographic changes, and a globalized world as well as technological development, AI, and digitization will continue to challenge us all to adapt. Technological advancements combined with improved transparency at the corporate and government levels will provide investors with opportunities to make decisions with fuller information.

Pensions continue to be one of the biggest looming issues, not just here in the United States but around the world. Japan recently reduced its discount rate on pension calculations because investment returns have fallen below historical levels. The recent strikes in France highlight the sensitivity of pensioners to any reduction in their benefits. And here in the US, teachers have struck in multiple places because they think pay and benefits are not growing enough.

Affordability issues add to the difficulty of US municipalities moving away from defined-benefit pension plans that are still viewed by civil servants as an important part of their compensation packages. Our citizens have gotten used to having a government responsible for saving for the future for us. Because that attitude is so imbued in our collective memory and because the financial crisis reduced many Boomers’ savings and investments, a substantial portion of the populace may not have the funds to afford the living and healthcare expenses that come with longer life expectancies. Will this trend bring back dependence on the family, or will it lead to even more dependence on the government and social service spending?

Even Japan is telling its citizens to take more responsibility for their retirement, since government pensions are expected to fall short because of the low birth rate (fewer workers to support retiree pensions), lower corporate contributions, longer life expectancies, and lower worldwide interest rates (https://www.japantimes.co.jp/news/2019/06/04/business/financial-markets/japans-pension-system-inadequate-aging-society-council-warns/#.XgZAE_x7lPY).

In the US, the extended General Motors strike resulted in some concessions to unions but not in the areas of pensions and where and how the company operates (https://www.wsj.com/articles/for-gm-the-strike-was-worth-it-for-the-long-run-11572627351?mod=searchresults&page=1&pos=6). Companies and employees need to be mindful of the needed flexibility to change in the face of ever-increasing technological developments, too.

State Pensions

The Pew Charitable Trust recently reported that many state pension funds have been reducing their investment-return assumptions (discount rates) to bring them closer to historical levels. That reduction increases the estimate of the unfunded liability as well as the annual contribution that the state should make to the pension so that the funded level does not fall even further. Lowering the discount rate is realistic and improves funding as long as the state budgets for the full annual contribution! These larger annual contributions can crowd out or compete with other spending needs. In our credit decisions we regularly consider the unfunded level of a municipality and how the municipality is addressing it. For example, we do not buy State of Illinois and some other state GO bonds because of outsized pension and budget issues, and thus we have avoided numerous downgrades over the years.

Illinois had ratings of AA by S&P and Aa by Moody’s in 2009, but by 2017 the state was downgraded all the way to BBB-/Baa3, where the ratings sit today. Similarly, New Jersey went from high ratings in the double-A categories to A-/A3 by 2017. Connecticut left the ranks of AA and sits at A/A1, while Kentucky’s ratings sit at A/Aa3.

US states may have a bit of a reprieve for funding competing demands. The National Association of State Budget Officers (NASBO) reported that state budgets grew by 5.9% in the 2019 fiscal year to about $2.1 trillion, the biggest annual increase since the recession and up from 3.7% growth in 2018. The report notes that states directed more to transportation projects, pensions, and reserves. We have observed that the continued improvement of rainy-day funds have been contributing to upgrades, and it is heartening to see that some infrastructure projects are being funded without an infrastructure plan. The state upgrades noted below both included an increase in reserves that contributed to the upgrades.

NASBO also reports that fiscal 2020 (most states have a June 30 fiscal year end) revenues are expected to grow 4.8%, slower than in 2019 but better than in 2018.

As the new year opens, governors will start giving their state of the state addresses and release executive budget plans. Continued growth is expected; however, many wonder how long the present expansion can last, so the trend of building and preserving reserves is expected to continue. In developing budgets, managers assess both the national and local economies and the health of local businesses and incorporate these assessments into budget expectations.

State Rating Changes

Arizona – upgraded by Moody’s to Aa1 from Aa

The upgrade reflects the state’s continued economic growth, the rebuilding of its reserves, and the reduction to its already-low debt burden. Arizona significantly increased reserves, in large part through the growth of its diverse economy over the last five years. Also, the state has paid down debt incurred prior to and during the recession, while limiting new borrowing. Other key factors in the Aa1 rating include below-average pension liabilities and demonstrated budget discipline.

Nevada – upgraded by Moody’s to Aa1 from Aa and by S&P to AA+ from AA

The upgrades reflect the state’s strong and growing economy, strong employment and population growth, and an increase in rainy-day reserves. The state also has moderate debt and pension burdens. Economic concentration in gaming and tourism add volatility to the revenue structure, but that is balanced by strong governance practices.

Battling the effects of climate change

A December 4th New York Times article started like this: “Officials in the Florida Keys announced what many coastal governments nationwide have long feared, but few have been willing to admit: As seas rise and flooding gets worse, not everyone can be saved. And in some places, it doesn’t even make sense to try.” The article was about Sugarloaf Key, which is in the process of likely deciding not to raise a three-mile stretch of road to protect the 12 homes along the road. The cost is prohibitive. To keep those three miles of road dry year-round in 2025 would require raising the road by 1.3 feet, at a cost of $75 million, or $25 million per mile. Keeping the road dry in 2045 would mean elevating it 2.2 feet, at a cost of $128 million. The debate about what happens to those homes and who pays or loses will remain lively, not just for Sugarloaf Key but for all municipalities that need to manage climate adaptation, including fireprone areas. (This year’s fires were not as monumental as it was feared they might be: See our “Fire and Water” commentary, https://www.cumber.com/cumberland-advisors-market-commentary-fire-and-water/.)

Municipal Markets Analytics, Inc. (MMA) notes that yield spreads between 2-year and 10-year bonds, which can be a measure of longer-term risks, are greatest for the states of Illinois, New Jersey, and Connecticut because of headline risk, which includes the sheer liability of pension shortfalls, as well as other budget problems. However, MMA notes that the differential in short- and long-term yields for North Carolina and Florida do not reflect potential long-term effects of climate change, even though both states have coastal areas with high property values and intensely concentrated economic activity. Perhaps investors are not worried about the long-term risks to the credit quality of those states because their economies and financial operations are currently strong and the states both have AAA ratings. Time will tell if the states and folks in those states adapt in a way that protects credit quality and ratings. As with Sugarloaf Key, the local response with or without the guidance of the state will be case studies in addressing climate adaptation risk.

Q4-2019-Credit-Commentary-Chart

In Sarasota, the Climate Adaptation Center (CAC) was introduced by means of the Global to Local: Adapting to a Warming Climate Conference in February (https://www.interdependence.org/events/browse/adaptive-climate-change/). The CAC intends to be one of the first of many regional centers bringing industry, academia, and government together in joint session to foster understanding of climate change and its Florida-specific impacts. The hope is to help society adapt to and mitigate the worst impacts in the most expeditious and cost-effective ways.

Cybersecurity

Cybersecurity risk is being addressed by numerous states and municipalities, and it remains a risk municipalities cannot afford to ignore. The State of Louisiana suffered a cyberattack/ransomware event on Nov. 18, which resulted in the state’s closing down agency systems for days while dealing with the attack.
The following are positive developments that will help address cyber risk.

  • The State of Ohio set up the Ohio Civilian Cybersecurity Reserve Force as a section of the National Guard. In a cyber event the 50 reservists currently in the program would be deployed while continuing to receive pay for their normal employment during that time. The state budgeted $100 million for the effort in 2020 and $500 million in 2021. Ohio also now has a chief information security officer (CISO), a position that is becoming the norm for municipalities and companies.
  • In Washington State, municipalities are required to have cybersecurity audits.
  • The Florida Center for Cybersecurity (Cyber Florida), hosted by the University of South Florida, is working on education, research, and outreach.

Credit Spreads

At Cumberland we are investors in high-quality bonds; however, we do pay attention to the high-yield market, which has performed well as investors reach for yield. This trend causes credit spreads – the difference in yield between high-quality and low-quality bonds – to narrow. We have noted for some time that corporate bond quality has trended down over the past few years, mostly due to increasing leverage. (See our Q3 Credit Commentary:  https://www.cumber.com/q3-2019-municipal-credit-bond-market-dynamics-natural-disasters-green-bonds-state-rating-changes-an-update-on-single-ratings/.) And just last week, numerous market outlets, including the rating agencies and broker dealers, commented that the high-yield bond market seems to have gotten ahead of itself and could be due for a correction.

Taxable municipal bonds still have relative value compared with corporate bonds in the longer end of the curve, an advantage of about 10 to 15 basis points. Taxable municipal bonds are not on all investors’ radar screens, and municipal bond issue sizes are not as large as those for corporate bonds, so large taxable funds do not participate as much.

At Cumberland we focus on high-quality municipal and corporate bonds because that quality is important to our clients. High-quality bonds are also more liquid, which is important for our active total return bond-management strategies.

All of us at Cumberland wish you a happy and healthy new year.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




State credits stable in 2020 outlook

Excerpt from…

The Bond Buyer

State credits stable in 2020 outlook
https://www.bondbuyer.com/news/state-credits-stable-in-2020-outlook?feed=0000015a-fd07-d6dd-a9ff-ff07c9a50000
By Sarah Wynn – December 04, 2019

Cumberland-Advisors-Patricia-Healy-In-The-News

Analysts predict states will be in stable condition this coming year with continued revenue growth, leading to more willingness to issue debt.

State revenues will continue to climb in fiscal 2020, though at a more moderate pace as national economic growth slows, according to a Moody’s Investor Service report released this week. Overall tax revenues will increase by about 4% in 2020, the agency projects.

States also have plans to spend more on education and contribute to record-high rainy day fund balances, analysts said. States have contributed more to rainy day funds recently, in part due to unexpectedly strong revenue growth.

If a recession were to hit and a state issued a lot of debt, pay-as-you-go can help them delay projects and decide to issue debt later. .

Issuers have gone out to bond more since interest rates have continued to decrease over the years, leading issuers to possibly think that this may be the last time interest rates will be this low, said Patricia Healy, senior vice president of research and portfolio manager at Cumberland Advisors.

“Interest rates are still low,” Healy said. “They got so low, that issuers decided to go to market thinking that maybe this is the last low.”

However, an economic downturn could lead to less issuance.

Full story (paywall): https://www.bondbuyer.com/news/state-credits-stable-in-2020-outlook?feed=0000015a-fd07-d6dd-a9ff-ff07c9a50000


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