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Time to Buy Munis

Many munis now yield more than Treasuries. Historically, it has been the other way around.

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This article first appeared in Kiplinger's.

Markets are pretty efficient, yet the patient investor can usually find a good deal. Recently, that deal has been municipal-bond funds. With the stock market taking a beating, finding a bargain that offers steady yields and strong protection of principal is mighty appealing. It makes sense that the stock market is down from its highs. After all, a lot of value has been destroyed in mortgages and housing, and oil prices--though down from their highs--are crushing a slew of industries.

But the beating that municipal bonds have taken makes less sense. The mortgage mess has indirectly stung munis because the companies that insure mortgages also insure munis, and the insurers' viability is in question. The upshot is that muni insurance isn't worth much these days. So, it would make sense for insured munis to slip a bit. Instead, all munis, including those that are not insured, have been punished way too hard. True, we're facing hard times in the economy. Yet in past recessions, the default rate for high-quality munis was about 1% or 2%. On top of that, investors' flight to quality is pushing Treasury yields to very low levels, and hedge funds are dumping munis. Put it together and you get an odd disparity.

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Russel Kinnel has a position in the following securities mentioned above: FLTMX. Find out about Morningstar’s editorial policies.