Quietly, this investment has been killing it

Suddenly, less is more.

The market for tax-exempt debt is suddenly hot, with the S&P Municipal Bond Index registering gains for the ninth straight month. Investors have been flocking to munis as their plump yields have traders salivating for yield.

But despite the gains, Sean Carney, municipal strategist for BlackRock, says investors should temper their outlooks.

"It has been a fantastic year, with the broad municipal bond index up about 9 percent on the year," Carney notes. Yet he believes there could be some rough roads ahead.

(Watch: Next worry—surging corporate debt levels)

"The fourth quarter tends to be more volatile than prior quarters as issuance picks up a bit," Carney said, and "we've had a recent rally as early as last week, where we saw a bit of a capitulation trade."

Dealers who supported the market may have taken on more risk at a time when primary issuance is picking up, Carney added.

Nonetheless, Carney still finds municipal bonds to be attractive. "Munis offer great relative value when you think about them on an after-tax basis," he said. Though the relative value ratios of munis compared to U.S. Treasury bonds or corporate bonds may have come down in the recent rally, "these ratios are resetting back to levels where we believe we'll find a bottom here rather quickly and get the market back to trading with a bit more liquidity."

State/territory issuer

Performance year-to-date





New Jersey


New York




Puerto Rico


Source: BlackRock

The performance marks a turnaround for a sector that was battling losses in the wake of the Detroit bankruptcy. And though Carney that event tainted the whole municipal bond market, he doesn't see similar situations arising elsewhere. "I don't think we can point to a specific bond or sector that looks so risky," he said.

(Read: US Treasurys hold losses in afternoon trading)

Still, there are challenges for some places, Carney cautioned. "The headlines are really going to turn towards pension reforms in the states that continue to struggle with pension reforms such as states like New Jersey, Illinois, Pennsylvania, [and] maybe to a little lesser degree, Connecticut," he said. "We've seen rating action taking on some of these states. And it's going to be very important that in the near term they continue to try and tackle this."

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