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[DewDiligence]

Municipal Bonds Are a Screaming Buy

[Munis never fully benefited from The Great American Bond Bubble (#msg-53466103), partly because the tax advantage of munis applies only to US investors. Now, a wave of fear about the financial condition of state and local governments has caused some munis to become so cheap that they are screaming buys. The most attractive muni funds, IMO, are those with an intermediate average maturity and no leverage.]

http://online.barrons.com/article/SB50001424052970204555504576075980500585362.html

›JANUARY 15, 2011
By RANDALL W. FORSYTH

From the way the beleaguered municipal-bond market is acting, you'd think American cities and states and localities were heading into a fiscal abyss as bad or worse than that of wobbly European sovereign debtors.

Thanks to dire predictions of an unprecedented wave of defaults in the muni market, investors in municipal-bond mutual funds now are stampeding to the exits—sending muni-bond prices plunging. But the drop more reflects the relative illiquidity of the tax-exempt bond market than it does states' and municipalities' finance troubles.

Last week saw wholesale selling of munis by some of the biggest-name fund managers to meet redemptions. Open-end muni funds have suffered nine straight weeks of outflows, totaling some $16.645 billion, a considerable sum absolutely, but not in the context of the overall muni market, which totals some $2.8 trillion. In the week ended Wednesday, outflows were $1.51 billion. Also, Vanguard shelved plans for three exchange-traded muni funds.

The iShares S&P National AMT-Free Municipal Bond exchange-traded fund (ticker: MUB) fell 3.3% on the week, to a 52-week low, and is down 11.7% from its peak, touched last August [a huge drop for a muni-bond fund]. But the surge in yields resulting from the plunge in muni-bond prices is attracting even savvy buyers for whom munis' tax-free interest is irrelevant.

Jonathan Beinner, Goldman Sachs Asset Management's chief investment officer and co-head of global fixed income, says pension funds are crossing over to the muni market to take advantage of what he calls a technical situation caused by heavy liquidations. Indeed, the Goldman Sachs Strategic Income Fund (GSZAX), which Beinner co-manages, has been moving into munis to take advantage of yields as high or higher than comparable taxable bonds.

Indeed, taxable-equivalent yields on muni bonds have moved back to levels not seen since the panic of 2008, points out Michael Darda, chief economist and strategist of MKM Partners. On a taxable-equivalent basis (what a taxable security would have to yield before taxes to equal the tax-free yield), Darda wrote to clients Friday that "long-term muni [general-obligation] bonds are yielding 8.3%. This compares with high-yield bond rates of 7.15%, Baa corporate bond yields of 6.08%, and a forward earnings yield on the S&P 500 of 7.4%. Thus, the risk/reward in munis looks increasingly compelling in our view."

On an absolute basis, the yield on the benchmark 30-year, triple-A muni bond topped 5% Friday, which equaled 111.5% of the yield on the taxable 30-year U.S. Treasury, notes John Hallacy, head of municipal research at Bank of America Merrill Lynch.

Another muni-bond pro observed that California GO bonds due in 2039, rated A-minus by Standard & Poor's, were trading at a tax-free yield of 6.10%. In comparison, fully taxable Mexican government bonds, rated triple-B rating by S&P, and Colombia's obligations, with a below-investment-grade Ba1 from Moody's, yield about 5.75%. Meanwhile, leveraged closed-end muni funds offer tax-free yields up to 8%.

Forecasts of a wave of municipal defaults totaling hundreds of billions contrast with actual experience. S&P reported Friday that actual municipal defaults totaled $2.65 billion in 2010, equal to approximately 0.095% of the $2.8 trillion muni market, down from $2.8 billion in '09. Smart managers are buying munis, not the hysteria.‹