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The Anti-Meredith Whitney Muni Trade

Fin - Breakout - US

Six months into it and Wall Street analyst Meredith Whitney's prediction for "$100's of billions in municipal defaults this year" is running more than a fair bit behind schedule. According to a Reuters report earlier this week, only 26 issues defaulted in the first half of the year, down from 60 in the first six months of 2010. The value of defaults fell sharply to $818.2 million in the first six months of 2011 compared to this point last year when defaults totaled about $2.8 billion, according to the Reuters data.

And yet with Moody's downgrade of Portugal to junk status and an ominous Federal debt-ceiling deadline less than a month away, fixed income markets continue to be roiled by credit concerns, contagion fears, and external events. But Leo Grohowski, the chief investment officer of BNY Mellon Wealth Management, says precisely what creates opportunity.

Grohowski says "municipal defaults rates will remain comfortably below 1%," adding that he's on the other side of the doomsday forecast by Meredith Whitney.

While he thinks a deal in Washington will be reached in time for the U.S. to make its mid-August debt payments as scheduled, Grohowski is actually underweight everything but municipals and TIPS (Treasury Inflation Protected Securities) in the fixed income asset class, including investment grade corporates, high yield and U.S. treasuries.

While Macke likens the "disproportionate power" of rating agencies to "3-year-olds with guns," Grohowski says they still play a role and you need to use them, but formulate your own view too. "Investors do understand that states and municipalities are under pressure and so you connect the dots and say, 'that's an asset class I shouldn't be in right now', and that creates an opportunity," according to Grohowski.

It doesn't take a derivative trader to see that 3-4% from a high quality tax-free bond is superior to 3% taxable on a 10-year treasury. Even so, Grohowski says "there will be more downgrades than upgrades effecting the principal value of bonds" and that investors now need to have the mindset of holding them to maturity. "You used to be able to ladder the maturities and be done with it," he says. And even though you can't do that anymore, doesn't mean you avoid the asset class (munis) all together.

What do you think? Would you park money in a municipal bond right now?

Your comments, as always, are welcomed below.