News & Letters


Keep Up-To-Date with Dupree


Letter to Shareholders: September 30, 2020

 

Dear Shareholder:

Compared to the first half of this year, the third quarter of 2020 was relatively uneventful for the municipal bond market. Bond market volatility was muted, and yields continued to grind slightly lower (i.e., prices moved higher). Despite ongoing worries about the fallout from COVID-19, credit conditions in the investment grade municipal bond sector have continued to hold up remarkably well with only a small number of issues receiving credit downgrades. Favorable supply-and-demand dynamics have continued to act as a tailwind for the municipal market. The Bloomberg Barclays Municipal Bond Index provided a total return of 1.23% for the third quarter and 3.33% on a year-to-date basis.

One slightly unexpected recent development in the municipal market is worth noting. On the supply side, state and local governments are issuing taxable municipal bonds at a record pace due to falling interest rates and the 2017 tax-cut law that restricted issuers’ ability to advance refund tax-exempt issues. The low interest rate environment has allowed state and local governments to refinance debt with taxable securities that cost less than what they are paying on outstanding tax-exempt bonds. So far this year, state and local governments have issued close to $100 billion in debt subject to federal income taxes. If the current pace continues for the remainder of this year, the supply of taxable municipal bonds may come close to or even surpass the $154 billion in taxable bonds issued in 2010 when the Build America Bond program expired. This refinancing activity should help ease budgetary fiscal pressures.

The credit quality of all of our investment portfolios remains very strong. We have taken proactive steps in a few of our funds to eliminate or reduce our positions in certain credits where we felt those holdings had a higher-than-average risk of a potential credit downgrade. Most of the bonds that we have sold (which represent only a small fraction of our overall investment portfolios) were in sectors that have been disproportionately impacted by COVID-19. Examples of such sectors include, but are not limited to, convention centers, airports, small colleges, and small rural hospitals.

From a portfolio strategy perspective, we have a current bias towards essential service revenue bonds that finance critical services such as water, wastewater, and electricity. Essential service bonds offer stable and sustainable revenue streams that are better protected in an economic downturn. We also currently favor bonds issued by school districts, flagship universities, and high quality national and regional health systems. Our portfolio managers are being extra careful when it comes to security selection, and they are spending a considerable amount of their time and efforts watching over all of the holdings in each of our investment portfolios.

The issue of providing additional financial assistance to states and localities is still under consideration by Congress. It looks increasingly unlikely that this matter will be resolved before the election. Regardless of whether additional federal aid is forthcoming, we think it is worth bearing in mind that state and local governments have a wide variety of tools at their disposal to recover lost revenues and manage their finances. Fortunately, most states entered the current economic downturn in relatively strong financial positions, many with sizeable rainy day reserve funds. Additionally, property tax revenue, which supports local debt issued by cities, towns, and counties, has increased as a result of a housing-sales boom stimulated by low mortgage rates.

Federal Reserve Update:

As expected, the Federal Reserve Open Market Committee (“FOMC”) left the federal funds target rate unchanged at 0 to 1/4% at its September meeting. However, in a surprise policy change, the FOMC adopted explicit forward guidance and indicated that any future interest rate hikes would be on hold until “inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” (Emphasis added).

In short, the FOMC has adopted what economists call an “inflation overshoot” into its forward policy guidance. This shift in strategy will permit the FOMC to worry less about fighting inflation and to focus more on achieving maximum employment and improving living standards. This represents a significant departure from past FOMC policy which has always been heavily tilted towards fighting inflation. Many of you probably remember Paul Volcker’s brute-force campaign in the late 1970s and early ‘80s to tame inflation. It appears that, after all of these years, the thinking at the FOMC has evolved.

As a practical matter, the new policy guidance means that interest rates will likely remain anchored at their current low levels for an even longer period of time since the FOMC has indicated that it will not start tightening monetary policy as early in the cycle, even if inflation reaches 2%. The FOMC’s updated economic projections which were released at the September meeting indicate that the majority of FOMC members don’t expect interest rates to rise before 2023. A stable interest rate environment should help municipal bonds continue to perform well.

New Online Access Shareholder Portal:

We are pleased to announce the recent launch of Dupree’s upgraded online access portal. The new portal offers a more user-friendly interface, easier navigation, and enhanced security features. Please note that all shareholders who wish to access the online portal must register with a new user id, even if they were previously registered under the old system. Shareholders may register by following the “Online Access” tab at www.dupree-funds.com. Please call us if you need any assistance with the registration process.

Thank you for the continued confidence that you have placed in us.

Sincerely,

 

 

Allen E. Grimes, Ill President

New Online Account Access Portal: September 23, 2020

Dupree Mutual Funds is pleased to announce the launch of our new and improved online access site which will be available starting on Wednesday, September 23, 2020.  Please delete any bookmarks you may have for our old online access site and add the following: https://dupreefunds.olaccess2.com/.  Please follow the simple steps to re-register your account for our new online portal. Due to security enhancements on the new site, you may not re-register with the same user id or password that you used on the old online access site.

If you need assistance or have any questions, please call Dupree Mutual Funds at 1-800-866-0614, Monday through Friday between 9:00 A.M. and 5:00 P.M, Eastern Time.

Letter to Shareholders: June 30, 2020

 

Dear Shareholder:

The first half of this year was in a word: tumultuous. The dictionary defines “tumultuous” as marked by violent or overwhelming turbulence or upheaval. With turbulence and upheaval on many fronts, the first six months of 2020 met that definition. Financial markets were not spared. A sell-off of historic proportions in mid-March caused prices of stocks, commodities, and bonds to plummet as a mysterious respiratory illness caused by a novel coronavirus (COVID-19) evolved into a full-fledged global pandemic. Stock and bond prices bottomed out on March 23, and the rout then reversed itself just as quickly as it started.

COVID-19 has exposed the fragility of our economy. Halfway through this year, 20 million are unemployed in the U.S., entire industries and sectors are shut down or are operating at minimal capacity, and global trade relations are reaching a new low point. It’s not a pretty picture. Nonetheless, financial markets have exhibited a remarkable degree of resiliency over the past few months.

What shape the economic recovery will take is an unresolved question. This is complicated by the fact that many areas are now experiencing a surge in COVID-19 cases. As we have discovered, reopening the economy will not be a linear process, and each city and state will have to make decisions based on its own particular circumstances.

Economists generally describe different types of recessions and recoveries as V-shaped, U-shaped, W-shaped, or L-shaped. While some economists are calling for a V-shaped recovery (a sharp but brief decline with a clearly defined trough, followed by a strong recovery), we tend to think that the recovery will be a long and slow process more akin to a U-shaped recovery. One noted economist described a U-shaped recession/recovery as being like a bathtub: “You go in. You stay in. The sides are slippery. You know, maybe there’s some bumpy stuff in the bottom, but you don’t come out of the bathtub for a long time.”

Cities and states are climbing out of a deep hole. Fortunately, most municipalities and states were in excellent fiscal shape before the crisis. Federal funding under the CARES Act and the ability of states and cities to borrow under the Federal Reserve’s municipal lending facility should help most jurisdictions cover current fiscal year deficits. However, addressing next year’s budget gaps will be a more difficult task. Moody’s Analytics estimates that states and local governments will need approximately $500 billion in additional aid over the next two fiscal years to avoid major damage to the economy. We think additional federal assistance is likely, but it is not a given.

As I pointed out in the March shareholder letter, we are staying busy evaluating the impact of recent events on our individual bond holdings. The fallout from COVID-19 is being felt in many sectors, but some sectors may be impacted more than others. Bonds issued to finance hospitals, nursing homes, airports, convention centers, museums, sporting facilities, small private colleges, and industrial projects are examples of credits that face an increased risk of a credit downgrade and/or default. Lower-rated bonds (i.e., high-yield) issued to finance these types of projects (which represent only a small share of the $3.9 trillion municipal bond market) have the greatest risk of default.

It is important to understand that the municipal bond market is bifurcated into investment grade credits and high-yield credits. Historically, the vast majority of municipal bond defaults have occurred in the high-yield space. We expect that this pattern will repeat itself. Forecasters at Barclays predict that in 2020 default rates for high-yield municipal bonds will be between 2% and 4%, up from about 1% in January. That compares to the historic default rate of approximately 0.18% for investment grade municipal bonds and 1.74% for corporate debt.

All of the bonds we hold in our investment portfolios are investment grade credits. While we do own a small number of hospital, airport, convention center, and stadium facility bonds in several of our funds, they represent a very small percentage of each portfolio’s overall holdings. Our portfolio managers have carefully reviewed (and will continue to monitor) each issuer’s financial statements to ensure that we remain comfortable holding these credits. If we identify any credits with which we are not comfortable, we will not hesitate to make adjustments to our investment portfolios.

At our core, we are risk managers. Frankly, that is where we add value for investors. In times like this, careful security selection and continuous oversight of investments have never been more important. Please know that we are staying very busy actively managing your investments.

Retirement Account Update:

President Trump recently signed into law a measure that suspends for 2020 the required minimum distributions, or RMDs, many retirees must take from tax-deferred 401(k) and individual retirement accounts. The Internal Revenue Service recently issued updated guidance that allows people who took RMDs from retirement accounts this year to put the money back in their IRAs. Please note that the deadline to return RMD’s taken in 2020 is August 31, 2020.

Retirement of William A. Combs, Jr.:

I would like to formally acknowledge the retirement of Bill Combs from our Board of Trustees. Bill joined the Dupree Mutual Funds board in 1988. His steady and strong leadership, sound judgment, and calm demeanor have been a tremendous asset to Dupree Mutual Funds and its shareholders over the years. All of us here at Dupree would like to thank Bill for his dedication and longstanding service to the Funds.

As always, we appreciate the confidence and trust that you have placed in us.

Sincerely,

 

 

Allen E. Grimes, Ill President

Pandemic Preparedness Update: May 22, 2020

 

 

We wanted to give you a brief update on some of the steps that we have taken to ensure that we are able to continue to provide you with the customer service that you have come to expect as the Coronavirus (“COVID-19”) situation continues to evolve. Dupree Mutual Funds (“Dupree”) is fully prepared and is committed to making sure that it protects the health and welfare of our employees, while at the same time ensuring that our customers maintain timely access to their investments.

Please be advised that as part of our response to COVID-19, Dupree has, among other things, taken the following actions:

  • Pursuant to guidance issued by the Centers for Disease Control (“CDC”), all employees have been instructed to stay at home if they feel sick or suspect they are infected with the virus that causes COVID-19.
  • We have undertaken increased health measures in our office such as cleaning all “high-touch” surfaces every day including counters, tabletops, handrails, desks, doorknobs, bathroom fixtures, toilets, and keyboards. Similarly, we have placed alcohol-based hand sanitizer and disinfectant wipes around the office for regular use by employees and customers.
  • Pursuant to CDC guidance, employees have been instructed to regularly wash their hands with soap and water for at least 20 seconds and to avoid touching their eyes, nose, and mouth with unwashed hands.
  • Pursuant to CDC guidance, we have reduced our staffing to ensure that proper social distancing protocols are followed.
  • We are following all guidance and protocols set forth in the Healthy At Work Requirements for Office-Based Businesses that became effective May 11, 2020.
  • We have stopped handshaking and will utilize other noncontact methods of greeting.
  • We will utilize videoconferencing for meetings when possible and employees have been instructed to avoid any large meetings or gatherings.
  • We have a Business Continuity Plan (“BCP”) which is tested on an annual basis. Our BCP outlines the steps that we will take in the event of a significant business disruption, including pandemic situations. Among other things, the BCP allows our employees to work from a remote location.
  • We have taken additional steps to protect our information technology systems from the increased risk of cyber events (e.g., systems being compromised through phishing attacks).
  • We will continue to monitor and follow guidance issued by the CDC, World Health Organization (“WHO”), and federal, state, and local regulatory bodies.
  • We have limited in-person customer transactions in our office to protect our employees and our customers. If you need to visit our office, please call us ahead of time to make an appointment, and we will be happy to assist you.

We want to assure all of our customers that our office is fully functional and open for business as usual. Our staff is here to answer any questions that you may have or to provide you with any assistance that you may require during this difficult time. Please don’t hesitate to call us at 859-254-7741 or 800-866-0614.

 

Letter to the Shareholders: March 31, 2020

 

Dear Shareholder:

As I write this letter to you from the Dupree Mutual Funds office here in Lexington, Kentucky, the novel coronavirus (COVID-19) pandemic continues to take its course throughout the world and here at home as well. Each of us will be impacted by this virus in some way, whether directly or indirectly, and we certainly cannot escape the unsettling effect it has had on all aspects of our individual and collective lives.

For those of you who are directly affected by COVID-19, suffering with illness or the loss of a loved one, our entire team at Dupree sends heartfelt sympathy, thoughts, and prayers. For those of you caring for the ill or for the broader health of our communities, we offer our support and gratitude.

While these are indeed unprecedented and unsettling times in many ways, I want to reassure you that, although we have made some adjustments, very little has changed here at Dupree Mutual Funds. While we are following guidance and recommendations issued by the Centers for Disease Control (CDC) and other public health agencies to ensure the health and safety of our employees and customers, our office is fully operational. Our staff is here to answer any questions that you may have or to assist you with any account service requests. We want you to know that we are committed to maintaining the exceptional customer service that you have come to expect.

Municipal Market Update:

The municipal bond market has not been immune to the uncertainty and volatility caused by the spread of this global health crisis. The municipal bond market enjoyed sixty straight weeks of positive inflows, and then suddenly and without warning, experienced a dramatic downturn. The downturn started during the week of March 9 as fears of COVID-19 mounted and the U.S. declared a public health state of emergency. Along with U.S. Treasuries, municipal bonds faced extreme liquidity challenges. The temporary loss of liquidity in high quality fixed-income markets was a stark reminder that there truly is no such thing as a “safe haven” asset when fear turns to panic.

This is precisely what happened over the past couple of weeks when investors frantically sold large amounts of their highest quality assets (mostly U.S. Treasuries and municipal bonds) to raise cash. The indiscriminate selling led to an unprecedented spike in municipal yields and sharply lower municipal bond prices.

Fortunately, the dislocation in the municipal bond market did not last very long, and the rout reversed itself just as quickly as it started. The Fed announced a wide array of emergency measures and funding facilities to assist financial markets. On March 15 the Fed lowered the target rate for the fed funds rate to 0 to ¼ percent. Subsequently, the Fed also announced a large scale quantitative easing (“QE”) program which includes a pledge to buy an unlimited amount of Treasury securities and agency mortgage-backed securities.

To help support the municipal bond market and to provide additional liquidity to money market mutual funds, the Fed announced a Money Market Mutual Fund Liquidity Facility (MMLF) that will allow eligible borrowers to pledge certain short-term municipal debt with a maturity not exceeding twelve months. Another stimulus measure authorizes the Secretary of the Treasury to inject cash ($454 billion) into the financial system by permitting the Fed to make open market purchases of longer-term state and municipal debt and also by backstopping lending to states, municipalities, counties, and corporations. The combination of newly announced monetary and fiscal policy measures quickly led to a positive change in investor sentiment which helped stabilize the municipal bond market and allowed tax-exempt yields to return to more normal levels. However, states and municipalities will undoubtedly come under additional financial pressure as the long recovery process begins.

Against this backdrop, we think there are a few key points worth keeping in mind. State and municipal issuers are essentially monopolies. Unlike corporations, government issuers have the ability to raise prices (i.e., taxes) to service their debt payments. This additional flexibility makes municipal bonds stronger than corporate bonds with comparable credit ratings. Historically, defaults of investment grade municipal bonds are very rare. Importantly, states are required by their constitutions to balance their budgets. Bonds also provide a valuable hedge against an economic slowdown or recession, which now unfortunately, seems inevitable. Finally, as recent market conditions have painfully reminded us, high quality bonds help smooth out the volatility of an all equity investment portfolio.

We are staying busy actively managing our funds and taking care of the hard-earned dollars you have entrusted to us. Our portfolio managers are working diligently to evaluate the impact of recent events on our individual bond holdings. Among other things, our portfolio managers are identifying and potentially reducing our exposure to any bonds in sectors that may be disproportionately affected by COVID-19. They are also carefully reviewing and monitoring issuers’ financial statements to evaluate credits for potential downgrade risks. In this environment, we believe it’s more important than ever to have an experienced professional keeping a close eye on your municipal bond investments.

Our late founder, Tom Dupree, would never miss a chance when bond markets got choppy and bond prices were volatile to remind me and others that when you invest in our funds you purchase a future stream of income. We think it’s helpful and also reassuring in times like these to remember that the bulk (in excess of 90% for periods as short as 5 years) of the total return of a fixed-income investment is derived from the income component. Over the long run, price changes (up or down) represent a very small component of the total return of a fixed-income investment. You can take some comfort in knowing that regardless of how choppy the market gets and no matter how much the share prices of our funds change, the dividends of each of our funds are expected to remain stable.

I want to take this opportunity to thank our employees for their hard work and dedication during this difficult time. They are a wonderful team of professionals. I also want to thank you for being a loyal and valued customer. None of this would be possible without your support. Please don’t hesitate to call us if we can be of service.

Take care and stay safe.

Sincerely,

 

 

Allen E. Grimes, Ill President

Pandemic Preparedness Update: March 24, 2020


As the Coronavirus (“COVID-19”) situation continues to evolve, we wanted to give you a brief update on some of the steps that we have taken to ensure that we are able to continue to provide you with the customer service that you have come to expect.  Dupree & Company, Inc. (“Dupree”) is fully prepared and is committed to protecting the health and welfare of our employees, while at the same time ensuring that shareholders of Dupree Mutual Funds maintain timely access to their investments.

Please be advised that as part of our response to COVID-19, Dupree has, among other things, taken the following actions:

  • Pursuant to guidance issued by the Centers for Disease Control (“CDC”), all employees have been instructed to stay at home if they feel sick or suspect they are infected with the virus that causes COVID-19.
  • We have undertaken increased health measures in our office such as cleaning all “high-touch” surfaces every day including counters, tabletops, handrails, desks, doorknobs, bathroom fixtures, toilets, and keyboards. Similarly, we have placed alcohol-based hand sanitizer and disinfectant wipes around the office for regular use by employees and customers.
  • Pursuant to CDC guidance, employees have been instructed to regularly wash their hands with soap and water for at least 20 seconds and to avoid touching their eyes, nose, and mouth with unwashed hands.
  • Pursuant to CDC guidance, we have reduced our staffing to ensure that proper social distancing protocols are followed.
  • We have stopped handshaking and will utilize other noncontact methods of greeting.
  • We will utilize videoconferencing for meetings when possible, and employees have been instructed to avoid any large meetings or gatherings.
  • We have a Business Continuity Plan (“BCP”) which is tested on an annual basis. Our BCP outlines the steps that we will take in the event of a significant business disruption, including pandemic situations. Among other things, the BCP allows our employees to work from a remote location.
  • We have taken additional steps to protect our information technology systems from the increased risk of cyber events (e.g., systems being compromised through phishing attacks).
  • We will continue to monitor and follow guidance issued by the CDC, World Health Organization (“WHO”), and federal, state, and local regulatory bodies and officials.
  • We have limited in-person customer transactions in our office to protect our employees and our customers. If you need to visit our office, please call us ahead of time to make an appointment, and we will be happy to assist you.

We want to assure all of our customers that our office is fully functional and open for business as usual.  Our staff is here to answer any questions that you may have or to provide you with any assistance that you may require during this difficult time.  Please don’t hesitate to call us at 859-254-7741 or 800-866-0614.

Letter to the Shareholders: December 31, 2019

 

Dear Shareholder:

What a difference a year can make. In 2018 virtually every asset class (municipal bonds & U.S. Treasuries being notable exceptions) lost money for investors. This year has been the exact opposite—virtually every asset class has generated strong positive total returns for investors. While a number of geopolitical events created lots of uncertainty and some market volatility, financial markets nonetheless demonstrated remarkable resiliency in 2019.

Like most other asset classes, fixed-income investments delivered above average returns in 2019. The municipal bond market enjoyed its best year since 2014 with demand for safe-haven assets and tax-exempt income pushing bond yields lower and bond prices higher. The Bloomberg Barclays Municipal Bond Index provided a total return of 7.54% for the 12-month period ended December 31, 2019. Tax reform, favorable supply-and-demand technical factors, benign inflation, declining default rates, improving credit quality, and a favorable interest rate environment all contributed to the strong performance of the municipal bond market in 2019.

The $10,000 cap on the State and Local Tax (SALT) deduction that was enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) increased the tax burden for individuals that itemize deductions and has led to a surge in demand for municipal bonds. The increased demand has been reflected in large municipal bond mutual fund inflows which have set a record this year. Even though the TCJA reduced the corporate tax rate from 35% to 21% (which resulted in banks and some insurance companies reducing their tax-exempt holdings), the decline in demand by these institutions has largely been offset by the surge in demand by retail investors.

At the same time that demand for municipal bonds has increased, the net supply of tax-exempt bonds has continued to decline from the peak levels seen in 2016 and 2017. Issuers have continued to be very efficient at calling higher coupon tax-exempt bonds. That, combined with the elimination of tax-exempt advance refundings under the TCJA, has significantly reduced the net supply of tax-exempt bonds. One of the most interesting developments in the municipal bond market this year is that low absolute interest rates and elimination of tax-exempt advance refundings have caused the supply of taxable municipal bonds to surge as states and municipalities have utilized more nontraditional bond deal structures. Taxable municipal issuance is expected to continue to grow with some analysts predicting that it could approach $100 billion in 2020 if interest rates remain stable.

Inflation is a fixed-income investor’s worst enemy. Fortunately, key measures of inflation have continued to be subdued. The Fed’s preferred inflation gauge, the core PCE, increased at an annual rate of only 1.6% in November which continues to run well below the Fed’s 2% inflation target. Near-term and long-term inflation expectations have also continued to be well anchored.

Default rates of investment grade municipal bonds have continued to run at historically low levels as credit conditions have continued to improve. State and local government revenues have continued to show signs of improvement. According to data compiled by the Urban Institute, combined state and local revenues were up 11.1% in the second quarter of 2019 compared to the same period last year. Many states have been successful in strengthening their rainy day reserve funds. According to rating agency data compiled by Moody’s Investors Service, municipal bond upgrades exceeded downgrades by a wide margin in 2019.

At the end of July, the Federal Reserve Open Market Committee (FOMC) surprised the market and cut the fed funds rate for the first time in over a decade. The July interest rate cut was followed by two additional one-quarter point cuts to the fed funds rate in September and October. Chair Powell has made it clear that the FOMC intends to keep the fed funds rate on hold for the foreseeable future. The FOMC’s pivot towards an easing stance acted as a tailwind for municipal bonds during the second half of this year.

I attended a municipal bond conference in New York City a couple of weeks ago that had lots of really smart and seasoned municipal bond market participants offering their views about where they think the municipal bond market is likely headed in 2020. The good news is there seemed to be a consensus that most of the themes that propelled the municipal bond market’s performance in 2019 would remain largely intact next year leading to solid returns, albeit slightly lower than this year.

One of the other main items discussed at the conference was the fast growing trend in the investment industry towards additional Environmental, Social, and Governance (ESG) investment. ESG investing has been touted as the next “disruptive” change in investment strategy and combines environmental, social, and governance factors into traditional investment evaluations and decisions. Among other things, ESG investing is driven by the concept that investment objectives and goals and personal values aren’t mutually exclusive.

One of the main takeaways was that, in many ways, investing in the municipal bond market represents the original ESG investment. After all, when states and municipalities issue bonds, the proceeds are frequently used to finance environmental or green projects such as wastewater treatment facilities or renewable energy projects (the “E”) or other socially responsible public projects such as hospitals, schools, and affordable housing (the “S”). Municipal bond issuers are invariably subject to good governance practices (the “G”) due to federal tax and disclosure requirements and other compliance obligations such as bond indenture requirements. Citigroup estimates that approximately $2.9 trillion, or 76% of the municipal market, is likely to screen well for ESG investors. We think that’s a powerful and comforting thought.

Thank you for investing with us. All of us here at Dupree appreciate your investment in the Funds and wish you the best in 2020. Happy New Year!

Sincerely,

 

 

Allen E. Grimes, Ill President

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.

Sincerely,

Allen E. Grimes, Ill President

Letter to the Shareholders: June 30, 2019


Dear Shareholder:

Mid-Year Municipal Market Update:

During the first half of the year municipal bonds posted strong returns. Bond prices rose (yields declined) as investors’ appetite for tax-exempt bonds increased. The boost in demand was fueled in part by recent changes to the federal tax code (i.e., the impact from capping the state and local tax (SALT) deduction for higher-income earners) and also by investors’ flight to safe-haven assets during a period which witnessed increased trade tensions and heightened geopolitical risks.

On the supply side, net new issuance of tax-exempt bonds remained flat. The supply of newly issued municipal bonds has been constrained by the new federal tax law that prohibits issuers from advance refunding outstanding bonds on a tax-exempt basis. Favorable supply-and-demand dynamics created a powerful technical tailwind for municipal bonds that contributed to the strong performance. On a total return basis, the Bloomberg Barclays Municipal Bond Index posted a 5.09% gain for the six month period ended June 30.

A favorable macroeconomic environment also helped support municipal bond prices. On the domestic front, economic data (e.g., business income growth and a slowdown in consumption during the first quarter) suggest that the pace of economic activity, while still positive, is beginning to slow. Manufacturing production has also posted declines so far this year. In the meantime, key measures of inflation have continued to be muted. The Fed’s preferred inflation gauge, the core PCE, increased at a 1.6% annual rate in May and continues to run well below the Fed’s 2% target rate.

On the international front, there are also signs that economic conditions are weakening. Earlier this year, the World Bank cut its forecasts for global economic growth in 2019 and 2020 for the U.S., the Eurozone, and China. Escalating trade tensions have cast a dark cloud over economic growth prospects around the world. The heads of several foreign central banks have recently suggested that they are prepared to roll out additional economic stimulus if economic conditions continue to soften.

Federal Reserve Update:

Against this backdrop, the Federal Reserve Open Market Committee (FOMC) met on June 19th and decided to leave the fed funds target rate range unchanged at 2.25-2.50%. From our perspective, we think the outcome of the Fed’s June meeting was notable for a couple of reasons.

To the surprise of many, the FOMC abandoned its use of the term “patient” to describe its approach to future policy changes. The “patient” language had just recently been adopted by the FOMC but was nowhere to be found in the FOMC’s June statement. Instead, the FOMC revealed that it plans to “closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion…” (Emphasis added). The FOMC’s pivot to a “ready to act” policy stance was a significant monetary policy development. We believe it pretty much confirms that the interest rate tightening cycle has officially come to an end. One voting FOMC member, James Bullard, voted against leaving the fed funds target rate unchanged, as he preferred to lower the target rate range by 25 basis points at the June meeting.

The FOMC’s change in its policy stance was sudden and fairly dramatic. The revised “dot plot” that is released along with the FOMC’s statement showed that eight of 17 Fed officials now expect a rate cut by the end of the year, with seven suggesting 50 basis points (bps) of rate cuts by year-end. Bond traders are feeling somewhat vindicated by the FOMC’s revised policy stance as they have been pricing in the possibility of a rate cut for some time. While market conditions can change rapidly, it looks like the next move by the FOMC will be a rate cut. Fed funds futures are currently pricing in a 100% probability of a rate cut in July (78% 25bps cut, 22% 50 bps cut).

The FOMC’s June meeting was also notable because Fed Chairman Powell seemed to tweak his comments about the significance of persistently low inflation. In his post-meeting press conference, Powell acknowledged that the FOMC was less confident in its previous pronouncements that low inflation readings were “transitory” in nature. He made a point to mention that wage growth was unlikely to “provide much upward impetus to inflation” and that weaker global growth could continue to hold inflation down around the world. Financial markets interpreted these dovish comments to mean that the FOMC would, if necessary, consider cutting interest rates to address stubbornly low inflation levels. The FOMC meets again on July 31, so stay tuned for more policy developments.

We think municipal bonds will continue their strong performance during the second half of this year. As a general matter, bonds perform well in a slow growth, low inflation environment. If current economic trends persist, the second half of this year looks like it will meet both of these criteria. Default rates of investment grade municipal bonds have remained at historically low levels. The credit quality of all our investment portfolios remains very strong.

The summer months are historically a period of net negative issuance (which occurs when the amount of maturing debt and refunded securities exceeds the supply of new issuance) for the municipal bond market. This tends to support bond prices. Citigroup estimates that over the next three months there will be -$47.7 billion in net tax-exempt issuance. At the same time, retail and institutional demand for municipal bonds continues to be very strong. Taken together, all of these factors should help support the municipal bond market in the coming months.

Thank you for investing with Dupree Mutual Funds. Please don’t hesitate to contact us if we can be of any assistance. Enjoy your summer!

Sincerely,

Allen E. Grimes, Ill President

Letter to the Shareholders: March 29, 2019

Dear Shareholder:
Municipal Market & Federal Reserve Update:

The municipal bond market is off to its strongest start since 2014. The strong performance has been driven by a number of factors including, but not limited to: the Federal Reserve’s decision this month to pause its interest rate hikes; the new cap on the deduction for state and local income taxes commonly known as the “SALT” deduction; and favorable supply and demand patterns.

The Fed’s March meeting was a game changer for financial markets. As expected, the Fed left the fed funds target rate range unchanged at 2.25 to 2.50 percent. However, several other actions taken by the Federal Open Market Committee (FOMC) took financial markets by surprise. The FOMC made it clear in its statement that it would be 11patient” as it determines whether additional rate hikes are appropriate. The switch to an 110n hold” rate policy stance is a substantial departure from the FOMC’s previous rate policy guidance which suggested additional tightening would likely be appropriate. In the press conference following the meeting, Chairman Powell reiterated his belief that the fed funds rate is currently at or near the long-run neutral rate. We may now be at the end of this rate tightening cycle. For the first time, some interest rate forecasters are predicting that the next move by the FOMC will be a rate cut.

The FOMC also made significant changes to its balance sheet normalization plan. Beginning in May, the re-investment cap for Treasuries will be reduced from $30 billion to $15 billion and then further reduced to zero at the end of September. In September, the FOMC will also start reinvesting runoff from its holdings of mortgage backed securities in Treasuries bought in the open market. The end result is the Fed will be purchasing approximately $200 billion more in Treasuries this year than financial markets originally anticipated and continuing to hold significantly more assets on its balance sheet going forward than it has historically carried.

The 2017 tax code overhaul capped at $10,000 the amount of state and local tax payments a household can deduct from its federal income taxes. Previously, a taxpayer could deduct the entire amount they paid in state and local property taxes, and either the state individual income tax or state sales tax. The cap on the SALT deduction has led to a spike in demand for tax-exempt municipal bonds as investors look for new tax shelters. The demand for tax-exempt municipal bonds has been particularly robust in high-tax states such as New York, Connecticut, California, and New Jersey. The increase in demand from retail investors has occurred at a particularly opportune time, as banks have continued to reduce their municipal bond holdings due to lower corporate tax rates which make tax-exempt debt less attractive for them.

During the first quarter, the pace of new bond issuance did not keep up with demand creating a supply and demand imbalance that resulted in higher bond prices. Although issuance volumes are expected to increase slightly in the coming months, a record amount of tax-exempt debt is scheduled to mature in the second and third quarters of this year. This runoff will generate a significant amount of cash that likely will be reinvested in tax-exempt bonds. Favorable supply and demand dynamics should continue to act as a support for municipal bond prices.

Bond markets have repriced dramatically in response to these developments with bond prices increasing and yields declining. At the end of the first quarter, the 10-year benchmark municipal bond yield as measured by the MMD AAA Municipal Yield Curve was 1.86%, the lowest it’s been since September 2017. The 30-year benchmark municipal bond yield dropped to 2.60%, the lowest it’s been since January 2018.

There are signs that the economy is slowing down. Real GDP growth in the fourth quarter of last year came in at 2.2 percent which was down significantly from the 3.4 percent growth rate experienced during the third quarter of 2018. Personal spending dropped substantially in December and was flat in January. The slowdown in economic growth does not appear to be confined to the United States, as Europe and China are also showing signs of weakening economic conditions. Importantly, key measures of inflation have continued to run below the Fed’s 2% inflation target rate. The Fed’s preferred inflation measure, the core PCE, increased at an annual rate of 1.8% rate in January.

The good news is that the combination of slower economic growth and subdued inflation is a benign environment for bonds. We think that conditions are ripe for municipal bonds to deliver positive returns for the remainder of this year. Particularly with the recent changes to the federal tax code, investors are increasingly discovering that tax-exempt municipal bonds are one of the last tax havens left. Also, with stock market indexes approaching last year’s record levels, we think it is important to keep in mind that, in addition to providing a steady stream of tax-free income, municipal bonds offer important diversification benefits for an overall investment portfolio.

On behalf of all members of the Dupree Mutual Funds family, I would also like to recognize the enormous contributions made to Dupree by C. Timothy Cone, who passed away on February 8, 2019. Tim served as a trustee of Dupree Mutual Funds for 16 years and was chairman at the time of his death. An accomplished and respected lawyer by trade and a steady leader in his profession and community, Tim shared his intellect, acumen, and loyalty with Dupree Mutual Funds to the benefit of all of us. He is and will be missed.

Thank you for investing with us.

Sincerely,

Allen E. Grimes, Ill President