The Improving State of the State

The Improving State of the State

“I busted a mirror and got seven years bad luck, but my lawyer thinks he can get me five.” – Steven Wright
Seven years ago California was facing a severe budget crisis. The state’s expenses exceeded revenues, creating an unsustainable path for the state’s finances, which ultimately unwound with the Great Recession in 2008. By 2011, California faced a $25.4 billion budget deficit (Source: California Department of Finance, Governor’s Budget Summary 2011-2012). Tough decisions had to be made, and through voter approved temporary tax increases and spending cuts, and some economic “good luck,” California has been able to regain a more stable financial footing.
As a result, demand for the state’s municipal bonds has surged this year,  (Source: Bloomberg Brief), and this increase in interest can largely be attributed to changes in the tax environment and improvements in the state’s fiscal health. Our broad view is that California is making a sustainable recovery that has had, and should continue to have, a positive impact on the state’s municipal market.
Today, tax revenues are up, largely driven by capital gains after a strong 2013 stock market rally. Arguably more important, however, is that California is beginning to show some fiscal restraint in order to better manage its volatile revenue stream into the future. According to the State Controller John Chiang, this year marks the first time since 2007 that the state has ended a fiscal year with a positive cash balance. In response to these improvements, all three major credit rating agencies have recently upgraded the state’s General Obligation (GO) bonds. Fitch and S&P raised the state’s rating to A from A-, while Moody’s upgraded the state’s GO bonds to Aa3 from A1, the highest level in 13 years.
Of particular interest to those of us on the ground, the supply and demand imbalance in the municipal market has been a positive driver of performance year-to-date. During the first half of 2014, California issued $17.4 billion in debt, or 36% less than the amount of debt issued during the same period in 2013 (Source: Bloomberg).  This supply-demand imbalance is not just a California phenomenon: nationally, new issue municipal bond sales are down 16 % compared to last year, and the $3.7 trillion municipal market is off to its strongest start since 2009. Year-to-date through the end of July, the Barclays California Municipal Bond index was up nearly 7%,  putting it in the top performing quartile of all states for the year. We expect the trend towards lower net new issuance to persist throughout the second half of the year, and are working hard to navigate this supply constrained environment on our clients’ behalf.
While California is not completely out of the woods yet, we believe the state is moving in the right direction and making great strides in the process. One area where we see value is in General Obligation and school district bonds in municipalities with a stable tax base. These types of bonds should benefit as the economy continues to recover.
It’s true what they say – time heals all wounds – and certainly that has been the experience here in California.  While there will continue to be headline risks and pot holes to avoid, the big picture is that there are attractive opportunities and the overall environment for California municipal bonds has changed dramatically over the past seven years.

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Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.


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