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Everyone’s got it wrong on munis: Strategist

Talking Numbers

Chris Mauro, Head of US Municipals Strategy at RBC Capital Markets, says muni bonds are cheap.

The big bond selloff may be dissipating, but investors are still selling off their municipal bonds. One strategist believes muni bonds are now relatively cheap.

For the week ending in October 16, municipal bond funds reported $1.3 billion in net outflows, according to data from Lipper. That makes it 21 straight weeks and 30 out of 33 weeks of outflows. Since March, municipal bond funds have seen a total of $58 billion in outflows.

(Read: US bonds boosted by worse-than-hoped US jobs data)

Chris Mauro, Head of US Municipals Strategy at RBC Capital Markets, notes that this is even bigger than the $50.2 billion in outflows faced by muni funds from November 2010 to August 2011.

Municipal bonds as a whole trade relatively closely to 10-Year US Treasury bonds but at a discount due to the riskier nature of municipal bonds compared the federal government's debt. The Barclay's Municipal Bond index currently yields about 3.14%. That's 62 basis points above the US Treasury's 2.52%.

But, while US Treasury yields have dropped from 2.72% over the last month, municipal bond yields are slightly up. Bond yields move inversely to bond prices; a drop in yields means bond prices have gone up. Likewise, a hike in yields means bonds prices have fallen. So, the market isn't buying municipal bonds the way they're buying US Treasury bonds.

Part of this may have to do with the market perception that risk has increased in muni bonds relative to Treasury bonds. While there was some uncertainty this past month with the US government paying its debts, muni bonds have been getting a bad rap thanks in part to Detroit's bond default earlier this summer and again in the beginning of October.

"The Detroit situation was not a big surprise to any institutional investor that follows the market," says Mauro. "But any time you have a situation that generates a considerable amount of headlines in the mainstream press, you're going to get a reaction from retail investors and that's exactly what we saw."

(Watch: Munis ‘in much better shape’ today: BlackRock pro)

As well, some outflows can be attributed to investors selling their bonds and buying stocks in hopes of getting higher yields. Since the start of the year, the S&P 500 index is up nearly 23%.

In the video above, Mauro makes the case that the selloff in municipal bonds makes them now more attractive.

To see what Mauro has to say about muni bonds and what he thinks will help turn it around, watch the video above.

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