Among the many anomalies that have occurred this year in the financial markets was the breakdown in the relationship between stocks and bonds, explains John Bonnanzio, editor of Fidelity Monitor & Insight Report.
Within the former, the usual safe-haven status of the $3 trillion municipal bond market crumbled. In effect, munis suddenly became a risk-asset as the fear of mounting credit downgrades and defaults dried up liquidity. I
In March and April, the Fidelity Muni Bond Index Fund (FUENX) — a proxy for this diverse market — dropped 8%. That’s a bruising decline for the normally staid asset class. In the midst of the crisis, new muni supply quickly exceeded demand.
Prices cratered (yields skyrocketed). Soon it was clear that without the Fed’s support, muni yields would rise further, thereby raising borrowing costs at the worst possible time. In addition, tax-filing extensions deprived local governments of much-needed cash flow.
By March 20, and continuing into April, the central bank threw its first lifeline to state and local governments. Using a combination of loan guarantees and eventually direct bond purchases, the muni market finally stabilized.
Though Fidelity’s muni funds still bled red in April, May saw a significant reversal in fortunes: on average, their six nationally diversified funds popped 2.5%. That erased most of their declines sustained in the prior three months.
Notably, Muni Bond Index is down just 0.5% for the year whereas Fidelity Limited Term Muni Income (FISHX) is up 0.7%. This begs the question: Were we too harsh to downgrade all but Fidelity Conservative Income Municipal Bond Fund (FUEMX) last month, or will our rating changes prove prescient?
For all our sakes, we hope the muni market improves. (If it doesn’t, bigger problems likely persist!) However, stress fractures are still present below the surface.
State and local budgets are now way out of balance. This suggests an increase in credit downgrades and probably some defaults. Finding off balance sheet expenses related to Covid-19 is essential. While Fidelity’s muni analysts are talented at mitigating credit risk, it’s impossible to avoid it entirely.
Already, rapid transit systems in New York and elsewhere are struggling, and revenue bonds may yet be squeezed by lackluster economic activity. As such, the only municipal bond fund recommended at this time is the safest: Fidelity Conservative Income Muni Bond.
