Podcast: Wildfires, Trump, and Taxes… What’s Next?

George Bory: I'm George Bory, chief investment strategist for Allspring Fixed Income, and welcome to SpringTalk. With me today is Nick Venditti. He's the head of the Municipal Fixed Income team at Allspring. And, Nick, I understand you're about to start making monthly appearances on SpringTalk.

Nick Venditti: It doesn't get more exciting than that, does it, George? Every month, the Muni team will be coming to you with information about the markets, the economy, and anything else we view as exciting and that you need to know.

George: Well, there's certainly a lot going on in the muni markets, so I'm really looking forward to it. Monthly muni moments with Nick. You know, is there anything that you want to preview to the group?

Nick: I mean, look, I think there's a lot going on, certainly with the political backdrop, which we'll be talking more about as Trump's first 100 days and presidency come to fruition. There're natural disasters taking place currently, which we'll be talking a little bit about today. And then, obviously, there are the macroeconomic dynamics that continue to play out not just for our asset class, but much more broadly across the financial markets.

George: Now, that's a good point, Nick. It's been a rough start in 2025, particularly for many people in California and specifically in and around Los Angeles. So, maybe a couple thoughts on how that is impacting the muni market; how it's impacting the bonds; and, really, how it is impacting investors as they think about municipal investments in and around Los Angeles.

Nick: Yeah, absolutely. I think, first and foremost, our heartfelt thoughts to all of the people impacted by the fires. Obviously, the loss of property, much more importantly, the loss of life, trumps anything we're going to talk about today. But, ultimately, this is impactful to municipal issuance, to municipal credits. You have seen pretty wide devastation through parts of Los Angeles County, particularly in places like Altadena, where the fires have kind of raged out of control for going on over a week at this point. We are obviously monitoring this situation incredibly closely. The good news, from a municipal perspective, is that the fires haven't been all that impactful to municipal credit, save a handful of names that potentially have some liability related to the fires. We've seen this in the past, not just in California, but in Hawaii most recently, where the power-generating issuers have been found liable for at least portions of the damage. And, so, I think investors in the California market need to keep a close eye on those names in particular, and we are doing that on a day-to-day basis here at Allspring.

George: OK. Well, thanks. I really appreciate that. And I'm sure we're going to be talking about that over the coming months. And it's certainly been in a lot of the commentary that you and the team have been putting out. So, thank you for that. Let's just take a quick step back and think about last year, the muni market, and how things are set up as we start—we’re already a couple of weeks in—but as we start 2025 and think about the market a little bit more broadly. 2024 was a pretty spectacular year. Another spectacular year with some macro volatility. Inflation up, inflation down, sticky throughout. Pretty healthy job market. No shortage of excitement on the political front with roughly 80% of the world going to the polls. But, more importantly, here in the U.S., one of the most spectacular and perhaps exciting elections of all time kind of created a wide mix of opportunities. And, in particular, I think it's really interesting to see in munis specifically, you had some of the best-performing parts of the entire fixed income market. The muni high yield market had a fantastic year. But on the high-quality end, we had markets that really struggled and, in some cases, had negative mark-to-market returns for the course of the year. So, how should we think about this year and position the muni landscape for investors?

Nick: Look, I think we live in a crazy world, right? We live in such a crazy world that we've normalized some of the volatility that exists. I've been talking to people about the election. We had a very contentious election. We had an election in which in the summer of 2024, there was an assassination attempt on a presidential candidate. In any other world, we would have woken up the next Monday and the markets would have been blood red. And then two weeks later, the other presidential candidate dropped out of the race. And in any other world, we would have woken up and the markets would have been on fire, but we kind of shrugged that off as well. And that contributed to excessive returns both in equity markets and in high yield fixed income asset classes. Investors got excited that yield was back and they went after it and went after it aggressively. But now we're sitting in a world where credit spreads are essentially as tight as they have ever been. Credit as a risk is as expensive as it's ever been. And, generally, when risk gets expensive, you want to take less of it or you want to take it a little more prudently. So, I think one of the big benefits of munis, and what we're seeing kind of develop as we march into 2025, are opportunities for investors to diversify their holdings, not just from a duration perspective but from a credit exposure perspective. I'm not telling you to avoid high yield completely. Absolute yields still look kind of attractive, certainly relative to where they've been over the last 5, 7, 10 years. But you need to be mindful that spreads are tight, and that means that you can get almost all the yield of a high yield portfolio by going up in quality substantially. You can get almost the yield of a long duration portfolio by staying a little bit shorter on the curve. And I think there's a real opportunity for investors to diversify their risks in fixed income.

George: So, I think you make a great point. There's the trade-off between interest rate volatility and credit risk. And credit spreads across markets, across fixed income are at fairly tight levels. How do you manage through the interest rate volatility side? If you look at just 10-year Treasuries, the typical year now of the Treasury has a range of anywhere from 100 to 150 basis points (100 bps equal 1.00%). That's some pretty big point moves as that volatility works its way through the market. How are you managing that in the muni portfolios?

Nick: Yeah. I mean, we've seen over the past couple of years on occasion, Treasuries trade like bitcoin, right? I mean, the incredible volatility in Treasury markets, unprecedented really, relative to any kind of meaningful history. And so, one of the big benefits of munis is that they're less correlated to everything, including Treasuries. And so, part of the reason—and we've talked about this a lot before, George—part of the reason that munis have had such great relative performance, relative to Treasuries, relative to IG (investment-grade) corporates, relative to esoteric ABS (asset-backed securities), whatever kind of fixed income asset class you're looking at, is because they have kind of sailed through this Treasury volatility in a much less dramatic way. And so, to the extent that we believe that that kind of volatility still exists in this market, I do think munis will continue to provide a real ballast to portfolios and can be a meaningful part of an asset allocation.

George: Well, a big source of volatility, at least this year, is likely to come from the new administration. With the reelection of Donald Trump and a pretty brave new fiscal and political agenda, sort of the headline assumption is that we're going to see tax cuts. We're going to see looser regulation. We're going to see tighter immigration policies and the use of tariffs in all sorts of ways makes for a challenging kind of cocktail—a mix, if you will—for bond investors, most of which is because of the increases and the uncertainty of some pretty big kind of macro assumptions. What’s your read-through when you think about the balance between federal opportunities or what's happening at the federal level relative to what's happening at the state level? There're some meaningful challenges as it relates to sovereignty and the opportunity that exists across the states and within the municipalities relative to the federal government.

Nick: I mean, there certainly are. I think at a high level, many of Trump's platform issues would potentially be wildly inflationary, which is an enemy of rates coming lower and bond prices going higher. I think we've already started to see Trump back off of some of his aggressive tariff rhetoric a little bit. So, it remains to be seen how ultimately that will play out. But I think it dovetails very nicely into the messaging we've been providing from Allspring for quite some time. And that we're bullish on fixed income for the income. We think the income stream is what's really going to be valuable to investors. It's hard for me personally to craft an argument that rates are going to come down materially. I think coming into 2024, everyone believed that rates were going to come down 100 basis points, so they went and bought lots and lots of duration. That didn't really come to fruition. I don't think it's going to come to fruition in 2025, either. But that doesn't mean that fixed income isn't really attractive because the income streams, both on the tax-exempt side and the taxable side, are really, really nice. I think from a credit perspective and what the political landscape may impact as it relates to munis is interesting as well. One of the important considerations for investors is the fact that muni issuers generally have to operate with balanced budgets. The U.S. federal government sort of doesn't, as evidenced by the fact that we have $37 trillion in debt. So, to some degree, muni issuers are localized economies. And that's not to say that there aren't localized problems, but I think an astute bond picker can really buy the right credits and avoid the wrong ones, can avoid some of the macroeconomic headaches that are likely to take place at the federal level by focusing on localities that are really, really outperforming.

George: So, you bring up a good point. The income matters. And the tax-exempt nature of that income in munis is hugely beneficial to individuals. Now, part of the Trump agenda is providing tax cuts. And those tax cuts are going to cost anywhere from $9 to $10 trillion over the next 10 years, if they're all implemented. And so, he's sort of scrambling around looking for ways to pay for that. And one idea that has been floated has been possibly eliminating the tax deductibility of municipals. Is that a realistic possibility for the federal government to decide that and push it down to the states?

Nick: No. Full stop, no. It's absolutely not for a number of reasons. First and foremost, I will tell you that people have been talking about removing the tax exemption from munis for longer than I have been alive. And it seems like every federal election cycle, this topic kind of percolates to the top for a little while and then falls away. The reason it doesn't make any sense is because it doesn't really matter where you fall on the political spectrum. If you are as far as you can be to the right or as far as you can be to the left, the reality is that municipal bonds fund everything we all agree we need more of, right? They fund essentially all of the education in this country. They fund almost all of the health care. All of the roads, tunnels, bridges, electrical grid infrastructure is funded by municipal bonds. It does not benefit any of us as private citizens to increase the funding cost of our own health care, of our own education, of bridges, so that they don't fall down, which is happening more and more frequently. Second, the actual dollar amount that is garnered from eliminating the tax exemption is de minimis when compared to the $7 to $10 trillion cost of extending the tax cuts, right? You are not going to make up enough of that deficit for it to be worthwhile. And then, lastly, there are 50,000 municipal issuers, give or take. That is a powerful, powerful lobby. If you start messing with their cost of borrowing, they're going to show up at the steps of Congress with pitchforks and torches and just slay the monster, right? It's just not really a feasible alternative.

George: Well, let's drill into those 50,000 issuers. So, what are some of the key state and sector themes you and the team have set up for this year?

Nick: Yeah. So, look, I think ultimately this is a market where security selection is as important as anywhere else, right? We have a gigantic pool of names to pick from. I joke with my equity portfolio manager colleagues that their benchmarks are the Russell 3000 or the S&P 500. 500 stocks. What do they do all day? We have 50,000. It's a gigantic opportunity set for us. But I do think there are some thematic ideas that are coming to the top. And some of those are directly impacted by the political environment. The one I'll highlight today and that probably we'll talk about throughout the year is the higher education sector. Higher education, I think, is a sector that is in for a rough future. It's in for a rough future one, because it costs too much money to send a kid to college. For any of you listening to this podcast who are currently writing that check, you know that in your heart. You know it intimately. It is very, very expensive. And in addition to that, we have too many colleges and universities and too few high school students. We have a demographic problem. We have reached peak high school student. They are declining every year from here until the foreseeable future. So, there is a supply-demand issue. You have an entire generation of people who have kids now, who have 15-year-old kids now who have spent their entire life living under the burden of student loans. If you're a 15-year-old sophomore in high school and the only story you have heard from your parents is how their student loans made it impossible for them to buy a house, impossible for them to get financing for a car, how excited are you to take out $250,000 to attend a four-year school? Probably not so much. And then lastly, we have a political backdrop that is, I would say, less friendly to higher education in general. The common rhetoric from the very far right is that higher education institutions are whatever, bastions of liberal propaganda, whatever the messaging is. But ultimately, if you are looking to cut expenses at the federal level, most colleges and universities receive at least some money, directly or indirectly, from the federal government. Those come through grants from the National Science Foundation or NIH. I could imagine a scenario in which those get rolled back pretty aggressively. And all of that, I think, leads to a less rosy credit background for the higher ed sector.

George: So, it sounds like the higher ed, we want to be underweight or maybe even altogether out of the sector for the most part. Let's try and end on a positive note. What sectors or states do we think actually represent pretty good value right now?

Nick: Yeah, I think there are a ton that actually represent excellent value, again, both from an absolute yield perspective and from a relative yield perspective. I mentioned earlier in this podcast that credit as a risk is getting expensive. The good news is you don't have to take a lot of credit risk to get a lot of yield. We are seeing a lot of opportunities in some of the boring sectors, to be honest with you, George. For the first time in a long, long time, we’re seeing opportunities in vanilla things like local general obligation bonds. We're seeing a lot of opportunities in essential service revenue bonds, water and sewer bonds, bonds that are throwing off yields of 4-ish%. If you're a 37% taxpayer, a 4% yield translates into a six and a half. Six and a half is a big number for the lowest volatility, highest credit quality, lowest correlated asset class. Six and a half, I would argue, is a number worth doing a cartwheel for. And you're getting that buying very, very high, very vanilla credits. And I think investors should largely take advantage of those opportunities.

George: Well, with that, Nick, thanks very much for being on today's podcast and sharing your insights. We really appreciate it. And I look forward to hearing municipal moments, which is scheduled to start next month. So, thanks again.

Nick: Thank you so much, George. It's always a pleasure.

George: And for our audience, thank you for joining us today on SpringTalk.