Time to Take a Break From Municipal Bond ETFs?

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 |  Includes: MUB, MUNI, SMB
by: Tom Lydon

A number of the country’s larger states face mounting budget pressure as a result of the slow economic recovery, which has caught muni-bond ETFs in a big sell-off. Moody’s Investor Service stated that U.S. municipal governments will face lower demand for debt and higher borrowing costs due to a combined budget deficit of $100 billion this year and the extension of Bush-era tax cuts, which lowered the attractiveness of muni’s tax-exempt status, reports Martin Z. Braun for Bloomberg. In December, investors pulled more than $12.5 billion from long-term U.S. muni-bond mutual funds.

The ratings company remarks that none of the states will default but a few might miss payments. In December, Meredith Whitney, a banking analyst, projected that 50 to 100 “significant” muni-bond defaults, valued at “hundreds of billions,” will occur this year.

A majority of advisors, portfolio managers and economists don’t believe that a slew of defaults will occur but they acknowledge that the probability of defaults has gone up, writes Jessica Toonkel for Investment News. Only $8.2 billion in muni defaults has come to pas in a $2.8 trillion market as of Dec. 10, said MMA managing director Matt Fabian, and only three defaults have occurred this year.

What now, then? Though a recent Wall Street Journal article noted that the situation in munis may not be as bad as some are saying, particularly because of the action some states are now taking to get their budgets balanced and under control.

But that doesn’t change the fact that munis have been slammed lately, driving most muni bond ETFs well below their long-term trend lines. If you’re using a trend following strategy, now might be a good time to consider your exit strategy until this situation resolves itself.

Max Chen contributed to this article.