Podcast: Tax On, Tax Off? Examining Bonds & the U.S. Election

George Bory: I'm George Bory, chief investment strategist for Allspring Fixed Income. Welcome to SpringTalk. Today, I'm here with Nick Venditti. He's the head of the Municipal Fixed Income team here at Allspring. Thanks for joining us, Nick.

Nick Venditti: Absolutely. Good to see you, George.

George: So, Nick, let's set the scene. The U.S. presidential election is in just a few weeks. So, let's talk a little bit about what bond investors should consider between now and then and even beyond. Because as you know, we've done a fair bit of research. And our research shows that divided government tends to be good for bond investors. But, conversely, united government, when politics, when political parties are all aligned across both houses of Congress as well as the presidency, that does tend to weigh on bond prices. And even digging a little bit deeper, we can make the statement that tax-exempt or municipal debt tends to outperform traditional taxable debt when we have united government. So, these factors are going to loom large as we think about markets not only just over the next few weeks but well into next year. So, Nick, from your perspective, what are municipal investors thinking about today when they think about the election and they think about outcomes?

Nick: Yeah, I mean, clearly, we are in the midst of a very friendly, civilized political election. I'm sure we can all agree that that's the case. And so, you mentioned divided government. And I think that's interesting, historically. But I think there's more than just the divide that exists between Republicans and Democrats as members of the Senate and Congress. There is a pretty sizable philosophical divide that exists politically in this country. And to the extent that fixed income tends to perform well in that scenario, I think we're setting up a market that looks pretty advantageous for that asset class, holistically. And then, to your point, George, munis—always a beautiful and unique snowflake—they tend to do well even when that divide isn't quite as big. So, we are bullish on munis given the political backdrop that we're currently facing.

George: What about taxes? Taxes matter. And in this political cycle, it seems like there isn't a tax rate that at least one party is willing to concede on. How should municipal investors, considering they tend to get tax preferential treatment, think about taxes as we go into next year?

Nick: I think the broader investment world's eyes have been opened to the power of tax-adjusted returns, right? Just the importance that tax management plays in building a holistic portfolio. The nice thing about munis is they've been doing this forever, right? That they play a role as a tax-sheltered asset class and always have. But the results of this election could have a material impact on the tax situation, not just for individuals but for corporations. And I think if you believe one, that this election is going to lean blue, then unfortunately or fortunately, depending on your viewpoint, marginal tax rates are going to change materially. That high tax rate of 37% is going to become 39.6% as quickly as it can. And the value of the tax exemption that munis provide is going to be even more attractive in that type of environment. If, on the other hand, the election goes red, I think people need to realize that although their marginal tax rate may not change—may not change—their overall tax burden is likely to. And the reason for that is because we have a whole bunch of municipalities throughout this country who are going to be forced to balance their budgets without the help of stimulus money, without the help of COVID relief. And the only way to balance their budget is to dip into your pocket. Your tax burden is likely to go up regardless of the outcome of this election. And again, I think the value of tax-managed strategies, the value of the tax exemption that munis provide, is going to be incredibly beneficial for most investors.

George: So, I think there's also another way to think about this is that some people like to say that the Fed, or the Federal Reserve, is more important than the White House. And while politics are certainly going to dominate for the next few weeks, we know that economics will dominate for the next many years and, ultimately, forever. So, when you think about changes at the Fed and the recent reduction in rates, how are you thinking about municipal portfolios? Specifically, as we think about the big pile of cash, the record $6+ trillion of cash that's sitting in various portfolios, a large percentage of which is in municipal money market accounts, how are you thinking about cash versus duration in the context of the Fed?

Nick: I think there are a couple of things that are worth considering. Certainly, the Fed and the actions that the Fed is likely to continue to take, right? We've seen the Fed already make the first move. They seem dead set on continuing to lower rates. I will say full stop that I am bullish on fixed income for the income. I think the income here is so attractive, both in munis and in taxables, that investors need to take a long, hard look at them. Any price appreciation you get, it's just going to be the cherry on top. But you may get that price appreciation, given the Fed seems pretty dead set on moving rates lower. But that in mind, I do think that we are entering a very interesting entry point for fixed income in general and munis in particular. Right now, I think investors have a unique opportunity to come into this market given the recent backup we've seen in Treasuries. The 10-year has now gone back above 4%. Opportunities from an absolute level look really interesting. From a fundamental level, they look very interesting. But the technical trade that's potentially building is pretty interesting as well. As you mentioned, George, there's a lot of money still sitting in money market accounts. And we are starting to see that trade unwind in favor of duration. Duration as a risk is cheaper. When risk gets cheap, take more of it. You can invest in ultra-short or short-duration portfolios that are out yielding money markets right now and have the ability to participate in that price appreciation should it come. And investors need to start thinking about that long and hard.

George: I love that theme that a little bit of duration goes a long way in this environment, that income is your driver, and that little extra duration helps. One last question, Nick. Any nuggets for our listeners on value? What does value look like to a muni investor? You've touched on a few things, but maybe there's a couple of little nuggets left.

Nick: I do think that this is a market where security selection matters, that buying the right bond at the right price at the right time matters. But what does value mean? It means that you are getting paid to take duration. You should. I think we are all aware that credit spreads across all fixed income markets are tight. From a relative perspective, credit looks expensive, but from an absolute perspective, yields are attractive. So, I do think there are opportunities, particularly in munis, where credit tends to be a lot stronger than their corporate cousins, to dip your toe a little bit into some of the lower investment-grade credit markets and maybe even for select investors into that high yield market to generate some additional yield. And again, that's yield that you can clip in your portfolio for the next, not 30 or 60 or 90 days, but the next 3 or 5 or 7 years.

George: All of those points are fantastic, Nick. And I think the central message is be nimble, be quick, be prepared to ride the curve, extend a little bit of duration, and capture as much income as possible. Use tax exemption to your advantage. All very, very good advice. So, Nick, as always, it's been a fantastic and fascinating discussion. Thanks for joining us. And for our audience, we hope to see you next time on SpringTalk.