Oct. 1 (Bloomberg) -- Now may be the time to sell your tobacco bonds.

The CHART OF THE DAY shows how one issue, the Tobacco Settlement Financing Corporation of New Jersey’s 5 percent bond due in 2041, has outperformed the Bond Buyer 40, a price index of long-term benchmark municipal debt, since the end of the first quarter of 2009. The New Jersey security gained 83 percent by the end of the third quarter, while the index rose 32 percent.

Long-term tobacco bonds, sold by states and municipalities to cash in on their shares of the 1998 settlement with cigarette makers, have rallied more than any other major segment of the municipal market this year, according to Bank of America Corp.’s Merrill Lynch & Co. About $37 billion of such bonds have been sold.

“I think the current rally has to do with money moving back into mutual funds, and the resurgence of high-yield muni funds, because interest rates on munis have fallen relative to Treasuries, and investors are still looking for 5-plus percent yields,” Richard Larkin, research director at Herbert J. Sims & Co., a municipal-bond firm in Iselin, New Jersey, said in an e- mail.

“I feel that if you still have tobacco bonds, this may be a good time to sell, with prices on some bonds as much as 50 percent higher than they were in the spring,” Larkin said. “In the long run, I don’t believe the rally is sustainable, given the predominance of bad news.”

The bad news for tobacco bonds includes declines in consumption driven by higher federal and state taxes, the industry challenging settlement payments in past years, and the likelihood of more downgrades in bond ratings, Larkin said.

(To save a copy of the chart, click here.)

To contact the reporter on this story: Joe Mysak in New York at jmysakjr@bloomberg.net.

Last Updated: October 1, 2009 12:38 EDT