The fundamentals of municipal bonds are so weak that they are likely to plunge at least 15 to 20 percent, said Jeff Gundlach, CEO of DoubleLine Capital, the asset-management firm.
He told CNBC that investors don’t make choices based on fundamentals and instead opt for low default and tax rates.
“People who own munis tend to own them for the tax benefit and they tend to own most of their assets, if not all of their assets, in the muni-asset class,” he said.
While Gundlach isn’t predicting a high default rate like analyst Meredith Whitney has suggested, muni bonds won’t keep trading at their current level.
“Between here and the end game, lies the valley. And the valley is full of fear. I think the muni market is going to go down by at least, on the long end, something like 15 and 20 percent,” he said.
Muni bonds will replace subprime mortgage bonds as a risky investment option, Gundlach said.
“But that kind of sounds like what subprime sounded like back in 2006. You had an AAA market that had never traded below par, the fundamentals were getting worse and it was owned for a technical reason,” he said.
He remains undecided on whether muni bonds can default, stating he is “agnostic on that.”
"I'm not saying high-yield is about to collapse, because I really believe the defaults will be low for a while. But the stuff that was issued in 2009, that is not good quality, nor was 2010, and it takes about 3, 4 years,” Gundlach said.
More institutional investors have bought muni bonds while the supply has shrunk, USA Today reported. States are also generating 6 percent to 7 percent more revenue compared to 2010 with only one-third coming from higher taxes, said Mark Zandi, economist for Moody's Analytics. States have a “zero” chance of defaulting, he predicts.
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