Muni bond market stays on recovery path

The municipal bond market continued to stabilize Wednesday after the vicious sell-off of the last three months, as prices of many bonds rose for a sixth straight trading session.

The rise in prices pushed market yields lower, though the rate of decline slowed from the previous few days. The annualized tax-free yield on the Bond Buyer index of 40 long-term muni issues nationwide (charted below) slipped to 5.79% from 5.80% on Tuesday.

The Bond Buyer yield had soared to a two-year high of 5.95% on Jan. 18, an increase of more than one full percentage point from mid-October.

Wall Street has been pleading with investors in recent weeks, trying to convince them that the risk of default on muni bonds remains extremely low despite a barrage of headlines about the shaky finances of many state and local governments.

?Tragic? is how one analyst described the sell-off, during a conference call held Wednesday by Deutsche Bank?s retail securities unit.

Some nervous individual investors have ignored those pleas and have pulled more than $31 billion from muni bond mutual funds since mid-November -- about 6.2% of total fund assets of $500 billion. That has worsened the sell-off by forcing some fund managers to dump bonds into a falling market.

But munis began to recover last week despite another large outflow from mutual funds.

The share price of the Vanguard California Long-Term Tax-Exempt bond fund ended Wednesday at $10.52, unchanged from Tuesday but up 1.1% from the 52-week low of $10.40 on Jan. 18. The shares had tumbled 9.4% from Aug. 31 to last week's low.

The iShares S&P National AMT-Free Bond exchange-traded fund rose to $99.45 a share on Wednesday, up from $98.72 on Tuesday. It has rebounded 3.3% from its low of $96.26 on Jan. 14.

David Kotok, who heads investment firm Cumberland Advisors in Vineland, N.J., believes that last week was a ?classic selling climax? in munis as spooked investors fled -- pushing tax-free yields to what he views as lucrative levels compared with taxable bond yields.

Selling climaxes ?do not happen often,? Kotok said. ?In stocks it was in March 2009. In munis we think it is January 2011.?

But others have cautioned that muni market volatility is likely to remain high as state and local governments wrestle with their budget woes.

In a report Tuesday on the credit-rating outlook for the 50 states, Fitch Ratings said that "although we expect that the credit quality of states will remain very strong and that most states will continue to be rated 'AA' to 'AAA', there's a likelihood of an above-average number of incremental downgrades or negative rating outlook revisions this year."

-- Tom Petruno