Munis continue their streak

Munis "hang 10" at summer end

Highlights

? Muni bonds have been riding market tailwinds for 10 months in a row.

? Valuations relative to Treasuries have become more attractive.

? Negative seasonal trends are not a near-term concern.

Peter Hayes, Head of the Municipal Bonds Group James Schwartz, Head of Municipal Credit Research Sean Carney, Head of Municipal Strategy

Market views

For 10 consecutive months, the municipal market has generated positive performance, with the S&P Municipal Bond Index up 1.43% in August and 7.26% year to date. Concerns about slowing global growth and increasingly contentious trade negotiations with China combined with expectations for ongoing stimulus from major central banks continued to drive U.S. interest rates lower in August. (Bond prices rise when rates fall.)

While muni bonds delivered yet another strong monthly return, the asset class underperformed Treasury bonds due to its richer valuations and some softening in the recent seasonal strength. During the summer months, reinvestment income (maturities, calls, and coupons) typically exceeds new issuance in the muni market, resulting in net negative supply and strong returns. This trend, which has been one of the key drivers of positive performance in 2019, was not as robust as expected in August.

The recent underperformance of municipals relative to Treasuries has reset relative valuations to more attractive levels. At the same time, retail investors continue to drive demand for the steady and appealing levels of tax-exempt income municipals can provide. With 34 consecutive weeks of muni bond mutual fund inflows, 2019 is on pace to be the best year for fund flows on record. Additionally, while the month of September is usually when the market's net negative supply turns positive, performance weakness has historically been more notable in October and November, making seasonal trends less of a nearterm concern.

Strategy insights

Acknowledging the possibility of continued geopolitical uncertainty causing increased volatility, we maintain an overall neutral stance on duration (interest rate risk) via a barbell yield curve strategy with concentrations in maturities of 0-5 years and 20 years+. We continue to hold a favorable view on credit and prefer revenue bonds, lower-rated investment grade credits, and issues in high tax states.

Duration

Sept

Short

Neutral Aug

Long

Yield curve Barbell strategy, preferring 0-5 and 20 years+

Overweights ? State tax-backed and essential-service bonds, particularly

in the Northwest, Sun Belt and Plains ? School districts

Underweights ? States and locals with poorly funded pensions (IL, NJ, KY,

PA, CT) ? Single-site hospitals in Medicaid non-expansion states ? Speculative projects with weak sponsorship, unproven

technology or unsound feasibility studies

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Credit headlines

Sangamon County Circuit Court Judge Davis denied a petition for a lawsuit filed by Illinois taxpayer John Tillman and New York hedge fund Warlander Asset Management that sought to invalidate $14.3 billion of Illinois general obligation bonds. The plaintiffs argued that the bonds violated the "specific purpose" requirements of the state constitution. Judge Davis determined that no "reasonable grounds ... exist for filing." Plaintiff Tillman has filed an appeal, which could create price volatility until the process is exhausted.

Denver Airport is terminating its partnership with Great Hall Partners to redevelop the 24-year-old terminal after months of delays due to substandard concrete found in the existing structure. Consequently, $189 million of municipal bonds issued by the Wisconsin Public Finance Authority on behalf of Great Hall Partners (headed by Ferrovial Airports) were impacted. The Airport and developer are negotiating the unwinding of the partnership and seeking to satisfy all interested parties, including bondholders; however, the overall matter calls into question the benefits of public-private financing structures in the municipal market.

The State of Texas has experienced a coordinated ransomware cyberattack affecting at least 20 local government entities according to a press release from the state's Department of Information Resources. One of the cybersecurity firms combatting the issue mentioned that this was likely "the largest coordinated attack on cities yet observed and, given the copycat nature of hackers, we are likely to see a continued acceleration of these kinds of attacks on U.S. locals." As the frequency of these attacks increases, governments will be pressured to allocate more budgetary resources toward IT departments, which, barring any corresponding revenue adjustment, would create strain on providing services.

Municipal and Treasury yields

3%

2 1.50

1 1.01

1.39 1.03

1.50 1.22

1.97 1.84

0 2-year

AAA Muni 8/31/19

5-year 7/31/19

10-year

30-year

Treasuries 8/31/19 7/31/19

Sources: BlackRock; Bloomberg.

Municipal performance analysis

S&P Municipal Bond Index Long maturities (20+ yrs.) Intermediate maturities (3-14 yrs.) Short maturities (6 mos.-3 yrs.) High yield High yield (ex-Puerto Rico) General obligation (GO) bonds California New Jersey New York Pennsylvania Puerto Rico

Aug 2019 YTD 2019

1.43

7.26

2.39

10.21

1.19

7.01

0.19

2.73

2.13

9.57

1.82

8.85

1.36

7.08

1.53

7.47

1.55

8.22

1.39

7.23

1.49

7.62

4.02

14.08

Source: S&P Indexes.

Investment involves risk. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income from tax-exempt bonds may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Past performance is no guarantee of future results.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 9, 2019, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. ?2019 BlackRock, Inc. All Rights Reserved. BlackRock is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Prepared by BlackRock Investments, LLC, member FINRA.

Not FDIC Insured ? May Lose Value ? No Bank Guarantee

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