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Are munis that risky now?

By Sheyna Steiner · Bankrate.com
Friday, January 28, 2011
Posted: 7 am ET

Municipal bonds continue to hog the spotlight as the debate continues over just how bad 2011 will be for state and local governments.

The Fundmastery Blog on Marketwatch.com neatly summed up what's going on in muni finance in the post "Muni bonds taking a double hit."

On Monday, Kurt Brouwer wrote, "Muni bond investors are wondering what the heck is going on. This relatively placid backwater of bonds is facing a perfect storm of fundamental weakness in municipal and state finance coupled with an environment in which interest rates are likely to trend upward over time."

Lower demand can push bond prices down and yields up. Rising interest rates have the same effect on existing bonds.

According to fund flow statistics from the Investment Company Institute, investors began fleeing municipal bond funds in November and the bleeding hasn't let up since.

Whether or not it’s an overreaction to the perceptions of danger depends on who's talking.

Some contend that muni investors should be as nervous as a long-tailed cat in a room full of rocking chairs. Other voices in the fray have struck more moderate positions.

For instance, Bill Gross, a co-founder of Pacific Investment Management Co., and manager of the largest bond fund in the world, announced his opinion on looming municipal defaults earlier this month.  

In the Bloomberg story, "Pimco's Gross clashes with Whitney over municipal-bond outlook," Gross downplayed the number of municipalities facing bankruptcies.

"I don't subscribe to the theory that there will be lots of them," he is quoted as saying on Bloomberg Television.

 A report released this week from the credit-rating agency, Standard & Poor's, piled on to the doomsayers bandwagon, The Wall Street Journal reported on Monday.

Downgrades of municipal bonds could increase this year. But, on the bright side, the S & P report said that most of the state and local government bond issuers will maintain their medium to high investment grade ratings, the story "Warning from S & P on Munis" reported.

That leaves investors to do due diligence when shopping for municipal bonds.

When I interviewed sources for the Bankrate 2011 interest rate forecast, "Brighter economy may dim bonds' appeal," Bill Larkin, fixed-income portfolio manager at Cabot Wealth Management in Salem, Mass., said, "Are there going to be problems in the municipal bond market? Definitely."

But, "there are pockets of strength. You just have to find where those are," he said.

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