The Effect of a U.S. Rating Downgrade

After August outflows, the municipal bond market turned bullish once again in September with four weeks in a row of bond fund inflows – and the last week more than doubling the inflows of the previous week. The month also saw a couple of true superlatives.

Biggest municipal bond fund inflow in a year

Municipals benefited from a September flight to safety as investors abandoned stocks. Tax-exempt funds gained $1.9 billion in September, the best monthly municipal inflow since September 2010. Investors continued the $29.3 billion stock mutual fund outflow in August by withdrawing roughly $4 billion more in the first three weeks of September.

Best municipal bond performance since April 2009

The municipal fund flow reversal was driven largely by the ongoing search for better yields. 10-year tax exempt municipals beat comparable Treasuries for five consecutive weeks – the best performance since April 2009.

Municipal meltdown prediction failing to materialize

Another contributing factor to recent municipal bond bullishness was more favorable media attention, as the apocalyptic predictions of a municipal meltdown are proving to be wildly inaccurate. Questionable math predicted hundreds of billions in municipal bond defaults this year and that has not occurred. As we mentioned in our Mid-Year Municipal Credit Update, less than $10 billion materialized as of June 30th. Actual defaults continue to be a small fraction of those erroneously foreseen.

Regardless of the direction of fund flows or fickle media attention, we always encourage our clients to “know thy bonds” through independent credit research. Please contact your investment specialist if you have any questions on these latest market developments.

Ronald P. Bernardi
President and CEO
Bernardi Securities, Inc.
September 7, 2011