May 29, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • China is ready to cut back exports of rare earth minerals Chinese media reports warned, including an editorial in the flagship newspaper of the Communist Party. (Reuters)
  • The U.S. Treasury Department declined to name China a currency manipulator, but expanded the number of countries on its watchlist for manipulation to 21 from 12. (Bloomberg)
  • "Recent data points suggest US earnings and economic risk is greater than most investors may think," said Michael Wilson, Morgan Stanley's chief U.S. equity strategist, in a recent note. (CNBC)
1 big thing: Sleepy municipal bonds are 2019's hottest asset

Illustration: Rebecca Zisser/Axios

It's been bonds, not stocks, that have drawn major investment this year and municipal bonds have attracted particularly large and consistent inflows.

What's happening: Thought of as a slow and sleepy asset class preferred by retirees and risk-intolerant savers, muni bonds saw record inflows during the first quarter.

  • The flows were spurred by the Tax Cut and Jobs Act, a reduction in muni issuance and the Fed's U-turn on interest rate policy, analysts say.

Details: Data from Lipper shows cash has flowed to munis every single week this year, and the asset class has seen cash inflows of more than $1 billion or more in 15 of the 20 weeks this year that Lipper tracks.

  • That has brought muni bond net fund inflows to $36.8 billion, already the 3rd largest annual net inflow ever for the muni bond fund group and the highest inflows this early in a year in nearly 3 decades.

"Taxpayers are experiencing the effects of the limit on SALT deductions, which in many cases are increasing tax bills," analysts at RBC Wealth Management wrote in a note to clients last month. "We anticipate tax-bill sticker shock could stoke additional demand for tax-exempt securities."

Why it matters: The asset flows show investors are eschewing risk. While equities have seen nearly $100 billion of outflows from mutual funds and ETFs so far this year, investors have pumped close to $150 billion into bonds, EPFR data shows.

"[M]any institutional investors today say they see taxable municipals as an attractive late-cycle asset class," Scott Sprauer and Robert Burke, municipal portfolio managers at investment firm MacKay Shields wrote recently for Pensions & Investments.

  • "With the U.S. economic recovery now longer than all but one in history, and the global economy still fragile, many of these investors welcome the higher credit quality and more reliable ratings stability of municipals vs. other fixed-income sectors."

Yes, but: Investors also have been chasing riskier munis in an effort to increase returns, pushing $8 billion into into high-yield muni bond funds, also known as junk munis, through the first 5 months of the year. That's the highest inflows through May since at least 1992, according to Lipper's data.

Bonus: Total return on bonds 2019
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Data: Lipper/Refinitiv; Chart: Andrew Witherspoon/Axios

Munis outperformed every other bond group in 2018, including emerging market and high yield, or junk bonds, that are considered high-risk/high-reward plays. They also outperformed the S&P 500 by about 8%.

  • However, this year muni bonds have not delivered the same return for investors.

What's next? RBC analysts point out that despite underperforming some corporate bonds and international issues, munis' first quarter return marked their best Q1 performance since 2014, while March's performance was the month's best since 2017.

What to watch: The strong appetite for munis has meant lower interest rates for some borrowers that don't fit the typical definition of municipal bonds, WSJ notes.

  • And even some muni bonds with top ratings may hold substantial risk, Barron's reports. Billions of dollars worth of bonds’ ratings are being reviewed for a potential downgrade by ratings agencies Moody's and Fitch, after a recent appellate court decision related to Puerto Rico's bankruptcy case raised questions about the special status of so-called special-revenue bonds.
2. The China-U.S. travel spending decline
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Data: National Travel and Tourism Office; Chart: Andrew Witherspoon/Axios

One of the few areas the U.S. holds a trade surplus with China is in travel. Significantly more Chinese visit the U.S. every year than Americans visit China, spending an estimated $36.3 billion last year.

  • Tourism has been a major boost to U.S. businesses and has helped reduce the overall trade deficit with China.

Why it matters: The increase in tourism spending by Chinese year-over-year has been markedly slowing since 2016 and is seriously threatened by the escalating trade war, the U.S. Travel Association warns.

  • "The difficulty with trade skirmishes is that the unintended consequences are hard to predict, and we were concerned from the start that tensions with China might affect business and other travel to the U.S.," said the group's executive vice president for public affairs and policy Tori Barnes.
  • "The irony is that travel exports have been the greatest success story of our trade relationship with China, generating a $30 billion surplus and accounting for 19% of all our exports to that country in 2017."
3. Consumer confidence bounces back
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Data: The Conference Board; Chart: Axios Visuals

The Conference Board said its index of U.S. consumer confidence rose to a 6-month high in May and is now close to the 18-year high it touched last fall.

  • "Consumers expect the economy to continue growing at a solid pace in the short-term, and despite weak retail sales in April, these high levels of confidence suggest no significant pullback in consumer spending in the months ahead," said Lynn Franco, senior director of economic indicators at the Conference Board.
4. Bloodletting continues for firms in opioid lawsuit

Equity analysts at UBS downgraded pharmaceutical companies Teva and Mylan significantly on Tuesday, highlighting pending litigation and an "unclear path to upside."

  • Teva's stock price fell more than 12% to a 19-year low following the downgrade as the lawsuit, which alleges Teva joined with other companies as part of a generic drug price fixing racket, continued to hammer the company.
  • Mylan's stock fell nearly 6%. The two pharmaceutical companies are the biggest manufacturers of generic drugs.

Driving the news: Teva on Sunday agreed to pay $85 million to settle claims with the attorney general of Oklahoma for its role in the opioid crisis.

  • Generic drugmakers were hit by a price-fixing lawsuit filed by 44 states alleging 20 corporate defendants conspired to fix prices of more than 100 generic drugs, raising prices by more than 1,000%.

The big picture: UBS analyst Navin Jacob, who downgraded his price target on Teva to $12 from $22, said in a note that the generic drugs and opioid lawsuit open the company up to a potential $4.1 billion in damages.

  • Mylan shares have tumbled nearly 20% since the lawsuit was announced earlier this month, and Teva's stock has fallen by around 33%.
Dion Rabouin