Prof. Jeremy Siegel speaks at LINC 2018. (Photo: Lila Photo for TD Ameritrade Institutional)

Democrats and Republicans may compromise on Congress providing financial aid to U.S. states that need assistance, with the battle coming down to the “dividing line” between aid directly related to COVID-19 costs vs. pension costs and any other pre-virus fiscal issues states have, according to Jeremy Siegel, professor of finance at Wharton and WisdomTree senior investment strategy advisor.

On Tuesday, House Democrats unveiled a $3 trillion aid bill that includes money for states. Republicans indicated they were in no rush to begin negotiations.

Discussing investments in municipal and other bonds, Siegel pointed out Monday, during his weekly conference call on the state of the markets, that “there has been some concern about the burden on municipals” as a result of the pandemic and accompanying economic slowdown.

There is specifically “some concern that the big push for fiscal support” by the federal government “has waned a bit now that the stock market’s back,” according to Siegel. There is a “little bit less urgency and there’s a question of whether there’ll be a further stimulus” provided by the federal government, he said.

President Donald Trump’s chief economic advisor, Larry Kudlow, recently said the White House would like to pause before a fourth coronavirus aid program is developed, although he doesn’t rule it out. Congressional Democrats have been pushing for an aid package that would include more funds for states and cities, but Republicans, led by Senate Majority Leader Mitch McConnell, R-Ky., and Trump, have opposed such funding. McConnell has suggested that states file for bankruptcy if they can’t balance their budgets, which is not legal.

It is a “delicate question about funds to states and cities,” Siegel said, explaining: “The Republicans do not want to just give money to bail out any excess spending that these cities incurred or pension obligations that they incurred before the coronavirus. However, there is a basic consensus that any extra expenses and shortfalls in revenue caused by the shutdowns and the coronavirus very well might be totally or almost largely taken care of by the federal government. But that is going to be, I think, the dividing line in the negotiations between the Republicans and the Democrats in Congress. The Democrats will obviously fight for more. Republicans will pull back.”

Even if COVID-19 didn’t come along, there are certain major cities that may default, he said, noting: “Some cities were already on the brink with pension obligations before that. And states.”

Regardless, “I don’t see any widespread, sudden municipal defaults that would play havoc with that sector” of the bond market, he said.

Of the recent suggestion by ex-Federal Reserve Vice Chairman Alan Blinder that the central bank should buy municipal debt outright, Siegel said: “I don’t think that’s necessary. I would rather see the fiscal authorities give through the states the supplements of the cost” related to COVID-19.

When it comes to potential investments in bonds, Siegel said: “The worst will be, in my opinion, long-term,” non-callable bonds “because they’re going to suffer the capital losses as interest rates rise. The callable bonds have a shorter effective duration. They will not suffer those losses. So, I would stay short in duration. I’d rather reach for yield on the credit side than try to reach it on the maturity side.”

Returning to the subject of China from the prior call, Siegel said: “I don’t think we’re going to see a tremendous ramp-up of tariffs” by Trump despite the president continuing to blame China for the COVID-19 pandemic and using the country as a “major whipping boy” during his reelection campaign. Echoing what he said last week, Siegel predicted: “I think it’s going to be more talk than action because the business community has never been fond of these tariffs.”

— Related on ThinkAdvisor: