Letter to the Shareholders: September 30, 2019

Dear Shareholder:

Financial markets are often quiet during the summer months as traders and investors are busy taking their summer vacations. This summer was very different. During the third quarter, a series of social, economic, political, and geopolitical events led to a spike in market volatility. Markets detest uncertainty, and these days uncertainty seems to be more entrenched in the world.

An escalating U.S.-China trade war; a messy Brexit; increased tensions with Iran (including an attack on a major Saudi oil facility that temporarily disrupted world oil supplies); protests in the streets of Hong Kong; surprise election results in Argentina; slowing global economic growth; the first interest rate cut by the Federal Reserve Open Market Committee (FOMC) in over ten years; and an inversion of part of the yield curve are just a few of the things that have impacted financial markets in recent months. I could go on, but suffice it to say, all of these developments combined to create a “risk-off” mentality across markets that prevailed for a good part of the summer.

The third quarter was characterized by a choppy stock market, wider credit spreads, and a substantial drop in bond yields (prices up) here and around the world. The decline in yields has been pronounced enough that many countries around the world are now experiencing negative interest rates. The U.S., U.K., Canada, Australia, and New Zealand are the only developed bond markets that do not have negative rates anywhere on their yield curves. Nonetheless, during the third quarter the yield on the 30-year U.S. Treasury fell to a low of 1.95%, which is close to a record low. Tax-exempt municipal yields have followed Treasury yields lower.

U.S. Treasuries and municipal bonds are viewed as “safe haven” assets and have benefited from a flight to safety during this period of heightened volatility. Despite a slight pullback in September, municipal bonds turned in a solid performance during the third quarter with the Bloomberg Barclays U.S. Municipal Bond Index (“Muni Index”) providing a 1.58% total return. For the first 9-months of the year, the Muni Index provided a total return of 6.75%.

The technical factors that have supported municipal bond prices throughout the year remain largely intact. Favorable supply-and-demand patterns have continued to act as a tailwind for municipal bond performance. Retail investors’ appetite for municipal bonds has remained strong. According to data compiled by the Investment Company Institute, municipal bond funds have experienced 38 consecutive months of inflows, and investors have added in excess of $45 billion to municipal bond funds so far this year. Demand by institutional investors such as property and casualty insurers, life insurance companies, and broker-dealers (banks being a notable exception because of lower corporate tax rates) has remained robust.

Issuance of tax-exempt municipal bonds picked up its pace a bit as states and municipalities took advantage of historically low yields. According to data compiled by Bloomberg, while states and municipalities have borrowed about $260 billion so far in 2019, $240 billion in debt matured and another $98 billion was called. Thus, despite a slight increase in gross municipal issuance, net tax-exempt issuance continues to be relatively flat to slightly negative. This supply deficit has been supportive of the municipal bond market all through 2019 and should continue to help support municipal bond prices in the fourth quarter.

Federal Reserve Update:

The FOMC lowered the fed funds target rate by 25 basis points at its meeting on July 31. This represented the first rate cut since December of 2008. The rate cut came in response to a slowdown in domestic and global economic growth and concerns about persistently low inflation levels. The FOMC met again on September 18 and trimmed the fed funds target rate by another 25 basis points. Chair Powell characterized the most recent rate cut as an “insurance provision” against ongoing economic risks. FOMC members appear to be divided about the future path of monetary policy with some expecting one more rate cut this year and others anticipating no further rate cuts.

A stable interest rate environment is generally bond-friendly, provided that inflation remains in check. Fortunately, key measures of inflation have continued to be subdued. The Fed’s preferred inflation measure, the core personal-consumption expenditures price index (PCE), increased at an annual rate of 1.8% in August which is still below the Fed’s 2% target rate. The headline PCE increased at an annual rate of 1.4%.

The municipal bond market has posted impressive returns for the first nine months of this year. We believe the combination of continued uncertainty, favorable supply-and-demand patterns, subdued inflation, and a benign interest rate environment should help municipal bonds finish out the year on a relatively strong note.

One of the things we probably don’t highlight enough is the “civic” component of investing in municipal bonds. In addition to providing steady returns, municipal bonds offer investors an opportunity to provide much-needed cash for public services. When you invest in municipal bonds, it allows local communities to build schools, highways, bridges, water and sewer plants, airports, and other critical infrastructure. In today’s uncertain world, we think municipal bonds represent a rare win/win proposition—an attractive investment that also permits investors to give back to their local communities.

Thank you for investing with us.


Allen E. Grimes, Ill President