WASHINGTON -- Despite current fears of a Clinton presidency gnawing away at the bond market, analyst and strategists are telling investors not to worry.
The market may hit some ups and downs over the next few months, they say, but there are hopes that after the election dust settles, interests rates will stay low or move even lower, mainly because of a continuing weak economy.
Moreover, the possibility of higher tax rates under a Clinton administration makes the appeal of the tax-exempt market to investors all the greater, analyst say.
Eager to attract investors, municipal dealers are counseling clients to buy now, at what they say will be the lows over the long haul.
At Shearson Lehman Brothers, analysts made a pitch for municipal bonds in a recent white paper sent to customers.
"Investors should prepare for a possible Clinton presidency -- and higher income taxes -- by increasing their holdings of tax-exempt municipal bonds while the current oversupply keeps prices low and yields high," a news release accompanying the study says.
The study is written by Shearson strategist W. Stansbury Carnes in New York and chief political analyst Thomas Gallagher, who is based in Washington.
They argue there is a good chance that Gov. Bill Clinton of Arkansas, if elected, will raise taxes on high-income individuals as part of his economic program.
Indeed, a key element in Clinton's economic program is making the rich "pay their fair share" with offsetting tax breaks for middle-income individuals and families. It is a position articulated by Clinton in his "Putting People First" program that he unveiled over the summer. Typically, higher tax rates increase the lure of tax-exempt securities as investors seek to shelter income.
Still, worries over a Clinton presidency are temporarily rattling the bond market, creating volatile price swings, and tempering immediate buy calls.
Market fears that Clinton will go for a stimulative budget package were fueled Friday by a Los Angeles Times article saying he has told his top economic advisers to devise a bolder spending plan than the one he has unveiled.
But many players say the lure of the tax-exempt market will remain strong no matter who is President.
"A lot of the fear about a Clinton presidency has already been priced into the market," said Joe Deane, vice president and managing director at Shearson Lehman Advisors. "The deficit is huge problem for everyone, and we will have to work within those limits.
"Any kind of stimulus package that comes out won't be that large."
Deane instead stressed that the compelling argument to buy municipals is they are relatively cheap to other markets. That factor, combined with a feeble economy, is expected to perpetuate a low interest rate environment over the long run.
"The real fear is that Clinton will win and there will be a massive fiscal stimulus that will enlarge the budget deficit and push the economic growth rate up significantly," echoed Bob Giordano, chief economist at Goldman, Sachs & Co. "Those fears will persist until the election is out of the way. No one really knows what will happen, but we expect a relatively small fiscal stimulus package, and fears will disappear, and economic fundamentals will rule the day."
One reason many analysts believe a Clinton presidency will ultimately help municipal bonds is the Democratic program's call for higher tax rates on wealthy individuals, who like to buy bonds to shelter income.
Clinton's economic advisors advocate an increase in the top marginal tax rate to 36% from 31%. The higher tax rate would apply to couples filing jointly with adjusted gross income of $200,000 or more and to individuals with income of $130,000 or more.
In addition, Clinton's plan calls for a 10% surtax on millionaires. For some, this could mean top marginal rates of nearly 40% analysts at Shearson Lehman say.
In the first televised debate among the presidential candidates Oct. 11, Clinton reasserted his plan to increase taxes on taxpayers earnings more than $200,000, although he did not specifically say how much he would raise rates. He also repeated his intention of providing "modest" tax relief for middle-class families, which he defined as those with income under $60,000.
Tax increases on the wealthy are a virtual certainty under a Clinton administration, not just as a matter of policy but as a way to pay for a variety of devices to spur business investment, said Les Alpertine, managing director of Washington Analysis Corp.
"Once you raise the rate on upper-income taxpayers, that guarantees that Congress will go along with a wide variety of business tax incentives," such as an investment tax credit, liberalized depreciation, restoration of passive losses for real estate, and liberalized use of individual retirement accounts, Alpertine said.
"It's not a matter of "if" it's a matter of ~how fast,'" Alpertine said about a tax rise on the rich. "You can count on it in the first 100 days."
Tax-Exempts Still Appealing
While the political landscape continues to develop, a number of analysts are quick to point out one sure thing: Municipal bonds are attractive now.
For a resident of Texas, a state with no personal income tax, Shearson calculates in its report an individual in the 31% federal tax bracket who buys a municipal bond paying 6% would earn the equivalent of 8.69% on a taxable investment.
A New York resident in the same tax bracket who buys a state issue would earn the taxable equivalent yield of 9.44%. For millionaires who might be forced to pay a 10% surtax, the top tax rate would jump to 39.6% and the tax-equivalent yield on the 6% bond would shoot up to 10.77%.
Current market conditions also make municipal bonds a good buy now, according to Shearson analysts.
They say prices are low and yields are high because of the huge wave of municipal, corporate, and household mortgage refinancings that have flooded the fixed-income markets.
Total municipal bond volume, including short-term notes, is at $226.64 billion for the year through last Friday, according to figures from Securities Data Co. That is an increase of 35% from the year-ago period's $167.47 billion and is only $2.16 billion shy of 1985's record volume of $228.8 billion.
The majority of market players do not expect supply to dissipate soon.
Issuers continue to rush to market, grabbing interest rates that are still low compared with bond yields from issues priced during the early and mid-1980s.
On Sept. 22, the 30-day visible supply of municipal bonds hit a record $10.86 billion. The figure covers the anticipated sale of issues with maturities of 13 months or more within the next 30 days.
The bulge in supply has narrowed the yield spread between municipal bonds and comparable Treasury securities.
As of Friday, triple-A municipals were yielding 83% of Treasury three-year notes. Triple-A five-year municipals were yielding 78.6% of equivalent Treasury five-year notes.
Short-Term Volatility Seen
Still, some analysts are cautioning that a Clinton presidency could temporarily shake the bond market and drive prices lower.
David Jones, chief economists for Aubrey G. Lanston & Co., said the Treasury market is already pricing in election-time jitters and worries over fiscal stimulus in a Clinton administration, and that more price erosion is in the picture.
"You should be at 7% [on the 30-year Treasury bond] right now based on the economy, and you're at 7.50%," he said. "So you got at least a half point on the election in the long bond already and you may have another half point to go."
The fear among some of market participants is that Clinton's program, with its dose of fiscal stimulus to jumpstart the economy, could lead to bigger federal budget deficits.
Clinton backs a $50 billion annual increase in outlays for infrastructure, education, environmental technology, and defense conversion over his first term in office. While these programs are to be offset by budget cuts elsewhere and higher taxes to cut the deficit, analysts remain skeptical.
Jeffrey Bell, president of Lehrman Bell Mueller Cannon Inc., estimates Treasury bond yields could be forced up as much as a full percentage point from the combination of a Clinton budget and higher tax rates as fixed-income investors demand higher nominal yields to maintain an acceptable rate of return on bonds.
In other words, Bell said, the "creditor class" of bond buyers will require higher yields to compensate them for higher taxes.
"Pretax bond rates will have to go up 100 basis points in order to take account of what Clinton is going to do," Bell said.
Other analysts say they are not convinced Clinton will push immediately for higher tax rates.
"My instinct is that it's an important part of the plan, but it's not the linchpin of the whole thing," said Stan Collander, director of federal budget policy for Price Waterhouse.
Collander said he expects that Clinton will be under pressure to be fiscally conservative and to seek spending cuts and other alternatives to higher tax rates to finance his budget.
The general edginess of the markets over the federal deficit will prevent Clinton or any other President from putting in place a massive spending program, some analysts say.
"If a fiscal package is enacted, it is likely to be relatively minor, probably in the $25 million to $50 billion range, and not enough to materially change the pace of economic activity," wrote Samuel Kahan, chief economist for Fuji Securities Inc., in a market letter to clients.
"One needs to realize that whoever is occupying the White House will be working under constraints that are real and binding," Kahan wrote. "The reality of a large budget deficit as well as domestic and international investor concerns about potentially inflationary policies should keep fiscal policy measures relatively small.
"This and the realization that any significant rise in rates might push the U.S. economy into a recession should act as a brake on any extravagant spending plans that may be offered," Kahan said.
Moreover, some of Clinton's advisers have talked of holding off on tax increases until the economy shows more strength. One idea that has reportedly been floated is to back a stimulus package and refrain from higher taxes until U.S. growth is back to a healthy 3%. That would be double the sluggish pace of 1.5% gross domestic product recorded in the second quarter.
"If you look at the first year of a Clinton administration and assume the economy is going to be where it is now, they're not going to be talking about raising taxes," said one analyst with a major accounting firm who did not wish to be identified. "They're talking about fiscal stimulus."
The analysts noted Clinton has already backed away from his call earlier this year to provide major tax relief to middle-income families, which suggest he will be flexible on the subject of tax rates.
Clinton originally called for an immediate 10% reduction in taxes on the middle class, which he said could save a typical family $350 a year. He dropped the idea in a later refinement of his economic policies outlined in an April speech to the Wharton School of Business, although he has continued to talk in general about relief for middle-income taxpayers.
Whatever the economic ramifications of the new presidency, market players have begun to think differently about what is driving the economy and bond prices.
"The markets are going to be concerned about inflation and the new presidency," said Steven Leslie, senior vice president of trading at M.R. Beal & Co. "We'll have to turn our attention to the new fiscal stimulus package. There's a changing psychology here -- a shift from stimulating the economy by monetary policy to driving it by fiscal policy."
But once the dust settles, municipals, as they have historically, will plod along in sympathy with the Treasury market's more volatile responses to the condition of the economy.
In a recent investment letter, Dean Witter Reynolds Inc. wrote that the market will be driven by changing demographics, as many baby boomers have reached their spending peak. With soft consumer demand and fewer household formations, that could mean growth will level off at a sluggish 2%, the firm suggests.
A Democratic victory "could have a significant bond market impact" during the first half of 1993 as Congress and Clinton work out legislation that adds to the budget deficit and stirs inflation worries, analysts at the firm say. But, they add, "It's our guess: that rates will be heading toward a new equilibrium of 6% to 6.5%.
