The municipal bond market is estimated to be approximately $3.7 trillion in size as of July of 2012, according to the Municipal Securities Rulemaking Board, making it one of the largest securities markets in the world. Whether investors are involved through exchange-traded funds (ETFs) or are directly invested in muni bonds, they should regularly monitor their positions to ensure their safety, particularly after Detroit’s troubling default on its general obligation (GO) bonds.
Bond investors can use a number of public economic reports to help with their research; gauging the macro-economic environment is just as important as picking the right region or city to invest in. In this article, we’ll take a look at six economic indicators that all muni bond investors should know about, and how these indicators can be used to make buy, sell, or hold decisions.
3 Key Indicators
Local Employment Data
Municipal bonds are backed by taxation, in the case of GO bonds, or project revenues, in the case of revenue bonds. In the former case, the ability of a government to increase taxes to meet its obligations depends a lot on the health of its labor market. Citizens that are working and generating an income tend to pay more in taxes and contribute to government coffers, while high unemployment can spell trouble, as was seen in Detroit’s deterioration.
The U.S. Bureau of Labor Statistics publishes regional and state employment and unemployment data on a monthly basis. With dates outlined in its Release Calendar, investors can track the unemployment rate in key municipalities and stay ahead of bearish trends. Quite simply, unemployment rates increasing faster than the national average are a bearish sign, while employment rates increasing faster than the national average are a bullish sign.
Here’s an example of Detroit’s unemployment rate versus the national average between March of 2012 and March of 2015, clearly highlighting the bearish trend ahead of its bankruptcy:
Housing Market Data
Aside from income taxes, the second largest source of income for many municipalities is property taxes, which depend largely on the housing market. Higher valuations for houses mean higher property taxes and greater revenues for a municipality. Conversely, a struggling housing market can quickly result in lower revenues that can have a negative impact on muni bonds, as was the case in some California municipalities following the housing market crash in 2008.
The U.S. Census Bureau publishes a number of different housing market indicators that muni bond investors can use to discern trends. For instance, New Residential Construction, New Residential Sales, and Building Permits all provide great insight into the health of the housing market in a particular region. Again, investors should watch for a municipality’s performance relative to the U.S. averages when making investment decisions.
Below is an example of Detroit’s sharp drop in privately owned, and newly authorized housing units, which again shows that the municipality was facing problems well before 2013, based on Census data:
State GDP Data
The best indicator of a municipality’s health is its gross domestic product (GDP), which measures the market value of all officially recognized final goods and services produced in the state. In general, higher GDPs mean greater income per capita and higher tax revenues. The greater number of goods and services also improves sales tax revenues and other metrics that can help put municipalities on stronger financial footing over the long term.
The U.S. Bureau of Economic Analysis publishes a number of different GDP data points for muni bond investors to consider. Muni bondholders should take note of the GDP by Metropolitan Area, which provides more specific data than state-wide GDP. Local personal incomes can also be useful indicators for determining the strength of various municipalities, as incomes correlate to the amount of taxes paid and taxpayers’ ability to continue paying taxes.
Below is an example of Detroit’s personal incomes, which had risen sharply in the past due to unionization, but fell sharply during the recession on a relative basis, providing yet another clue:
3 Key Economic Reports
A more conversational read compared to strictly raw data, the Summary of Commentary on Current Economic Conditions by Federal Reserve District, or the “Beige Book” as it is more familiarly known, has 12 sections from each Fed district bank. The designated Federal Reserve Bank that prepares this summary changes on a rotating basis.
The book is published eight times per year just before the Federal Open Market Committee (FOMC) meetings, usually comparing stats and data to the previously released Beige Book, and discerning whether the economic indicators have improved or declined. These indicators will include information about labor markets, wages and price pressures, retail and e-commerce activity, and manufacturing output. Forward-looking statements are also common, containing comments that look to the next few months or quarters, and these can be beneficial to potential investors. Looking at these indicators, a municipal bond investor can try to read into what the Fed will say during the next FOMC meeting.
The reach of the Fed cannot be underestimated. They will interview business leaders, bank presidents, members of other Fed boards and even other informal networks before summarizing it all in the Beige Book.
With that being said, the data is usually stale by the time it is released, and by itself the Beige Book is not likely to have a big effect on the markets in the short term. What investors care about is whether the report alludes to any changes being made in the next FOMC meeting. The Fed knows this and so typically says little without confirming what will occur in the near future, preventing a market move.
What is important about this report for municipal bond investors is the forward looking statements that are drawing conclusions from the data rather than just presenting the data itself. This gives investors a broad spectrum of data sources to use for research, adding a qualitative perspective in addition to the quantitative, and summarizing the data based on geography rather than just industry or sector. This last point is key for municipal bonds since it directly corresponds to the local economy or one in the near vicinity.
The major drawbacks to the Beige Book are that the data is stale by the time it is released, the Fed purposefully remains vague about future economic developments, and specific industry conclusions are hard to draw based on the report.
The Securities Industry and Financial Markets Association, or SIFMA, is a leading securities industry trade group representing securities firms, banks, and asset management companies in the U.S. and Hong Kong. It issues economic reports throughout the economy. The report municipal bond investors would be most interested in is the U.S. Municipal Bond Credit Report, which is released on a quarterly basis with the fourth quarter including a full-year summary and the U.S. Research Quarterly Report.
The Municipal Bond Credit Report reports on the trends and statistics of the U.S. municipal bond market, both taxable and tax-exempt, issuance volumes, outstanding bonds, credit spreads, rating changes, and highlights across most major municipalities in the United States. It is data heavy, using year-to-date criteria with brief explanations about the cause in the change from quarter to quarter. Investors looking for a summary will appreciate the breakdown in easy to read charts, and those reading the report for the first time can look to the end for the terminology. It is important to note that conclusions drawn are primarily based on the reader using the data.
In comparison to the Municipal Bond Credit Report, the U.S. Research Quarterly Report contains brief commentary and statistics covering the U.S. capital markets, including but not limited to municipal debt. An important thing to note is that the report is a summary based on the entire municipal bond market rather than a breakdown of each municipality. The factors the report looks at include issuance volume, including tax and tax-exempt issuance, refunding volumes, floating-rate notes, and variable-rate demand obligations. Keep in mind that it is a data heavy report with little commentary so investors may have to draw their own conclusions.
MSRB Fact Book
The Municipal Securities Rulemaking Board Fact Book, or MSRB Fact Book, offers a free and comprehensive report for historical trade statistics on a quarterly and yearly basis, delving into municipal market trading patterns, continuing and primary market disclosure in the municipal securities market, and interest rate resets for municipal variable-rate securities. The report goes as far back as 2005 on various types of municipal issues and trades. Investors will appreciate its easy to read format, which breaks down the information into clear and precise charts for the $3.7 trillion municipal bond market.
Trade summaries and trade trends can be derived quickly, with the report even giving the number of trades per hour with the average trade size. The report goes further and breaks this down into most active day of the week and number of trades by months after sale date. The top 50 most active securities in the U.S. Definitions for Terminology used in the report can be found at the end of the Fact Book. Lastly, investors should know that each year the MSRB tries to incorporate new data to provide more clarity into the municipal bond market.
The Bottom Line
Remember that investing is a discipline that rewards those who do their due diligence and know what is going on in the market place. Economic indicators can be very useful when analyzing municipal bonds, particularly when looking at trends over a long period of time. In the case of cities like Detroit, deteriorating employment data, housing data, and GDP/income figures provided investors with ample notice before the government actually announced its bankruptcy.
The Beige Book, SIFMA Reports and MSRB Fact Book are not likely to send shock waves through the municipal bond market upon release, but they provide insight into the macro-economic activity and provide commentary above the raw data releases of other reports. They also give investors an opportunity to flex their analytical abilities to locate trends provided in the charts and graphs.
In the end, muni bondholders should be mindful of all of these indicators when analyzing new purchases and tracking existing holdings.