3rd Quarter 2017

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We begin this quarter-end review with Chart 1 below, which shows the AAA general obligation municipal bond yield curve on three dates: June 30, 2017, September 29, 2017, and October 11, 2017. What does the chart illustrate? A whole bunch of nothing!

AAA General Obligation Municipal Yield Curve

Granted the summer is supposed to be slow in the municipal bond market, what with issuers on vacation and bankers in the Hamptons. But this lack of activity is ridiculous; one-year rates were higher by 0.07% from June 30, 2017, through September 29, 2017, and 30-year rates were up 0.10% over the same period.

The supply of new issue municipal bonds was down 25% for the third quarter 2017 and down 16% for 2017 year to date. New money flowing into the municipal bond market that originated from municipal bond funds declined 43% in the third quarter 2017, compared to the third quarter of 2016. Over the past 12 months ending September 27, 2017, cash flows into municipal bond funds, as reported by the Investment Company Institute, were $1.7 billion. Cash flows into municipal bond exchange traded funds (ETFs) amounted to $5.0 billion for the year to date ended September 30, 2016, and $4.6 billion for the year to date ended September 27, 2017. For the quarter ended September 27, 2017, ETF cash flows amounted to $1.2 billion vs. $1.6 billion for the same quarter in 2016.

Credit quality in the municipal bond market has been pretty stable except for some idiosyncratic disturbances. Illinois, for example, went down to the wire to pass its first budget in three years. The rating agencies threatened to drop the state’s credit rating to below investment grade, which would have seriously limited its bonds’ marketability. These antics caused the price of Illinois debt to go dramatically lower prior to the ultimate passage of the budget, after which it rallied considerably.

Elsewhere, several prominent high-yield securities came to market and were very well received. One was a mall in New Jersey across from the Meadowlands, which has been mothballed for approximately 15 years. Originally called Xanadu and referred to as the “ugliest building in New Jersey” by the governor, it is now called “The American Dream Mall” in its recent incarnation. The fact that this and other non-rated, high-yield projects are so well received is more evidence of how income starved investors have become in an overly accommodative central bank world. By the way, we did not purchase this bond issue because visitation needs to be 2x that of Disney World just to break even. And, when Amazon is disrupting everything from retail goods to groceries, we felt the last thing New Jersey needed was another mall.

The New Administration’s Agenda, U.S. Economy, and Fed Policy

The Trump administration took office in January of 2017 with an aggressive agenda. It promised to repeal and replace the Affordable Care Act (ACA), known also as Obamacare, increase infrastructure spending, scale back federal regulatory constraints on businesses, and reform the federal tax code. Initially, the promise of this pro-growth agenda caused interest rates to increase substantially upon Trump’s election in November. This was followed by further increases in December as investors sold municipal bonds to capture losses that appeared to be more valuable in 2016 than 2017. Some nine months later, the repeal and replacement of the ACA has failed to become a reality—tripped up in both the U.S. House and Senate.

Meanwhile, the silence around increased infrastructure spending is deafening. Federal regulatory constraints have been eased only through executive orders. The process for tax reform has just begun, but the administration’s initial measure appears to be hitting a rough patch as the proposed removal of the federal deduction for state and local taxes (SALT) has generated some blowback. The president’s framework for tax reform was mute with regard to continuation of the tax exemption for municipal bonds, although several sources have attributed the administration to stating that municipal bond tax exemption is safe. The president’s proposal does call for the repeal of the alternative minimum tax. All that said, this is Washington, DC, and with tax reform a major piece of the president’s agenda, watching this sausage get made will be interesting. This sausage making process has been spiced up by the Twitter exchanges between the president and several members of Congress.

After a rather punk showing for the first two quarters of fiscal 2017, in which gross domestic product (GDP) growth was 1.8% and 1.2%, respectively, the economy generated a 3.1% GDP growth rate in the third fiscal quarter. The fiscal fourth quarter estimates of GDP have varied greatly as the impact of three devastating hurricanes (Harvey, Irma, and Maria) are taken into consideration. After considering the impacts of Harvey and Irma alone, Goldman Sachs lowered its third-quarter GDP estimate by 0.8% to 2.0%

Nonfarm payrolls have been a bright spot for the economy, averaging 168,000 new jobs per month for the first 11 months of fiscal 2017. This is a little lower than the 219,000 average monthly job growth rate generated in fiscal 2016. This all translates to an unemployment rate of 4.4% as of the end of August 2017 versus 4.9% at the end of fiscal 2016. One explanation for this slowdown is that employers cannot find qualified workers. This theory is substantiated by another significant economic indicator, the U.S. Job Openings and Labor Turnover Summary (JOLTS), which measures either newly created or unoccupied positions where an employer is taking specific actions to fill these positions. In July, this measure registered a reading of about 6.2 million, which is the highest since the time series began in December of 2000.

The Phillips Curve, an economic theory posed by A.W. Phillips, states that inflation and unemployment have a stable and inverse relationship. As unemployment decreases, inflation is supposed to increase. As of yet, this theory has not manifested itself. In fact, the Federal Reserve Board’s (Fed) favorite inflation measure, the Core Personal Consumption Expenditures Index (Core PCE)—which measures prices paid by consumers for goods and services without the volatility from movements in food and energy prices—has declined throughout the year. The last available reading at the end of August 2017 (1.30%) is much lower than the one at the end of September 2017 (1.80%).

On September 20, 2017, Bloomberg reported, “Federal Reserve Chair Janet Yellen acknowledged that the fall in inflation this year was a bit of a ‘mystery’ but suggested that the central bank was on course to raise interest rates again in 2017 nonetheless.” Any increase would be on top of the three hikes in the Federal funds rate in fiscal 2017, bringing the range for the Federal funds rate from 0.50%–0.75% to 1.00%–1.25% on June 14, 2017.

In addition, the Fed will begin reducing its $4.5 trillion balance sheet in October by slowly unwinding the stimulus program it engaged a decade ago to combat the Great Recession. Its plan is to reduce its holdings of U.S. Treasury and mortgage- backed securities by $10 billion in October of 2017 and gradually raise the reduction amount in the months ahead. Essentially, this reduces the demand for these securities from a purchaser that was not altogether economically motivated in the traditional sense. The Fed believes that the economy is strong enough that this gradual reduction of its balance sheet will not be disruptive, although some do not share this opinion. CNBC reported in August 2017, in an interview with JPMorgan Chase CEO Jamie Dimon, that he:

“…stopped short of saying the bond market is on the cusp of a collapse, but said he wouldn’t personally buy any long-term government debt. ‘I’m not going to call it a bubble, but I personally wouldn’t be buying a 10-year sovereign debt anywhere in the world…my view is the Fed is doing the right things, raising rates, telling people we’re going to start reducing the balance sheet,’ Dimon added.”

Current Portfolio Positioning

We have positioned our portfolios at the bottom ends of their respective risk spectrums. If this sounds familiar, it is, as we said the same thing last year. We have lower durations, higher credit quality, and higher reserve positions (to hedge against increased market illiquidity).

We believe that investors are not currently being compensated to take much risk. Real yields (yield less inflation) are low by historic standards (off the bottom but still low). Credit spreads are very narrow, back to pre-crisis levels, when 50% or more of the new issue market was insured by AAA municipal bond insurers. This is particularly concerning, as today only about 7% to 8% of the new issue market is insured and the municipal bond insurers are no longer rated AAA. A few desperate municipal market issuers, like Hartford, CT, are openly discussing debt restructuring, and the president is making comments like the following with regard to Puerto Rico’s debt: “You know they owe a lot of money to your friends on Wall Street. We’re gonna have to wipe that out.” The precedents set by the recent municipal Chapter 9 proceeding of Detroit, Michigan, and San Bernardino, California, have, in effect, placed bondholders in a subordinated position to pensioners. Sometimes investors are motivated more by greed than fear and vice versa. Greed seems to be the current primary motivating factor, and it is in such an environment that caution should be exercised. That is exactly what we are doing—relying on value-oriented, bottom-up fundamental analysis in portfolio construction.

Why Own Municipal Bonds?

Fixed income assets are an important part of a well-diversified portfolio, as they provide a stabilizing force to the potential swings of the equity portion of the portfolio. These asset classes are not always positively correlated and can therefore dampen the overall portfolio’s volatility.

Thank you for your continued trust in us.

Important Information

 As of 9/30/17

1 Yr

3 Yr

5 Yr

10 Yr

Inception 1/1/1985

Limited Term Municipal Composite (Net)






Limited Term Municipal Composite (Gross)






Bloomberg Barclays 5-Year Municipal Bond Index






BofA Merrill Lynch 1-10 Year Municipal Index






Performance data for the Limited Term Municipal Strategy is from the Limited Term Municipal Composite, inception date of January 1, 1985.

 As of 9/30/17

1 Yr

3 Yr

5 Yr

Inception 4/1/2014

 Low Duration Municipal Composite (Net)




 Low Duration Municipal Composite (Gross)




 BofA Merrill Lynch 1-3 Year Municipal Securities Index




Performance data for the Low Duration Municipal Strategy is from the Low Duration Municipal Composite, inception date of April 1, 2014.

 As of 9/30/17

1 Yr

3 Yr

5 Yr

10 Yr

Inception 11/1/1991

 Intermediate Term Municipal Composite (Net)






 Intermediate Term Municipal Composite (Gross)






 BofA Merrill Lynch 3-15 Year Municipal Index






Performance data for the Intermediate Term Municipal Strategy is from the Intermediate Term Municipal Composite, inception date of November 1, 1991.

 As of 9/30/17

1 Yr

3 Yr

5 Yr

Inception 5/1/2009

 Strategic Municipal Income Composite (Net)





 Strategic Municipal Income Composite (Gross)





 BofA Merrill Lynch Municipal Master Index





Performance data for the Strategic Municipal Income Strategy is from the Strategic Municipal Income Composite, inception date of May 1, 2009.

Each composite above represents all assets under management in fully discretionary, fee based accounts. Returns are calculated using a time-weighted and asset-weighted calculation including reinvestment of dividends and income. Returns are annualized for periods greater than one year. Individual account performance will vary. The performance data quoted represents past performance; it does not guarantee future results. Portfolio returns net of fees may include management, advisory and/or custodial fees. Thornburg Investment Management Inc.’s fee schedule is detailed in Part 2A of its ADV brochure. Portfolio returns gross of fees do not reflect the deduction of management fees. Performance results of the firm's clients will be reduced by the firm's management fees. For example, an account with a compounded annual total return of 10% would have increased by 159% over ten years. Assuming an annual management fee of .75%, this increase would be 142%.

**Index not yet incepted.

Unless otherwise noted, the source of all data is Thornburg Investment Management, Inc., as of 9/30/17.

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.

The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.

Portfolio construction will have significant differences from that of a benchmark index in terms of security holdings, industry weightings, asset allocations and number of positions held, all of which may contribute to performance, characteristics and volatility differences. Investors may not make direct investments into any index.

Please see our glossary for a definition of terms.