A Mardi Gras vibe for
municipal bonds?

Bottom line up top:

• Did a not-so-festive February tee up a middling March? After rising in January, U.S. equity markets lost ground in February, with the tech-heavy Nasdaq Composite and S&P 500 indexes posting some of the weakest returns, led by notable declines for several of the “Magnificent Seven” mega cap growth companies. Meanwhile, value-oriented and defensive areas, along with non-U.S. equities, have continued their year-to-date outperformance. The MSCI EAFE (Europe, Asia and the Far East) Index, for example, is beating the S&P 500 by roughly seven percentage points year to date, largely because the EAFE’s weighting in the information technology sector is only 9% — versus 30% for the U.S. benchmark.
  
  Fueling February’s drawdown in U.S. stocks was a combination of lofty equity valuations, concerns around tariffs, expectations for higher inflation and interest rates, and a batch of bearish economic indicators. Signs of slowing growth are unlikely to sway the U.S. Federal Reserve to accelerate its rate-cutting plans, although cracks are beginning to appear in the foundation of consumer resilience. In the final two weeks of February, however, the University of Michigan’s Consumer Sentiment Index and The Conference Board’s Consumer Confidence survey fell well short of expectations, with the latter gauge suffering its largest one-month contraction since August 2021. Additionally, we saw a large drop in consumer spending in the latest PCE data (-0.2% in January versus an expected +0.3%).

• Preparing for a lion’s roar — or a lamb’s “baa.” Following the carefree spectacle of Fat Tuesday, Ash Wednesday ushers in a decidedly more solemn tone. But even if a potential scarcity of simple pleasures in economic and market data dampens investors’ animal spirits in the coming weeks, there are still opportunities to allocate to assets that may be well-positioned for higher interest rates and sticky inflation. One area worth considering: municipal bonds. Fundamentals for this asset class remain sound thanks to healthy balance sheets for municipalities and strong growth in tax revenues. According to the U.S. Census Bureau, state and local tax revenues grew 8.6% for the 12-month period ended 30 September 2024, supported by positive trends in housing prices (Figure 1).

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Portfolio considerations

As many Mardi Gras revelers abruptly pivot to reflection and self-discipline, municipal bond investors may be less inclined to make such a shift. That’s because the environment for municipals seems closer to the unofficial motto of Mardi Gras: “Laissez les bons temps rouler” — let the good times roll. In our view, sound asset class fundamentals support the compelling yields and risk-adjusted return potential that munis offer.

Municipal bonds finance essential infrastructure projects at the state and local level across the United States. These bonds are secured by taxes or dedicated revenue streams from projects like toll roads, airports and utilities. The strength of this security pledge and the vital nature of the projects funded by the bonds add to their appeal. Within municipals, we favor three specific areas:

Transportation. This sector is well-positioned thanks in large part to airports. In 2024, the Transportation Security Administration (TSA) reported a record 904 million air travelers (Figure 2), up +6.6% from pre-COVID (2019) levels. This robust demand has triggered a boom in terminal expansion and modernization. Airport bond issuance was above average at approximately $20 billion in 2024, and we expect a similar level in 2025. Financial metrics for most airports also remain favorable, with solid debt service coverage ratios and ample liquidity.

State and local governments. Positive fundamentals and momentum make this a worthy sector for investment. Through the first three quarters of 2024, state and local tax revenues were +5.4% higher on a year-over year basis. State “rainy day” fund balances stood at 13.2% of general fund spending at year-end and are projected to increase to 15.0% this year, while median reserve balances have grown every year since 2011. Lastly, we anticipate credit quality will stay stable and healthy. 2024 tax collections were well ahead (+28%) of pre-pandemic levels in 2019, and most states took in revenues that were in line with their budgets.

Water and sewer utilities. Providers of these essential services often enjoy monopoly or near-monopoly status, which offers the advantage of stability. Sector liquidity is impressive, with a median of 550 days of cash on hand — above the pre-pandemic level of 498 days. Leverage remains low, creating additional debt capacity, and environmental regulation of water and sewer systems should ease. While this will allow more time to comply with EPA rules, it will also require further borrowing to meet new clean drinking water and lead pipe replacement mandates. Given the sector’s sturdy fundamentals, these upcoming projects should open up attractive opportunities for investors.

Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

Regular meetings of the GIC lead to published outlooks that offer:

• macro and asset class views that gain consensus among our investors
• insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
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