Will The Rally Continue?

The week began with a sharp selloff on Monday due to escalating trade tensions, but markets rebounded strongly in the following days, led by gains in technology stocks.

Key Drivers

Tech Sector Rally: Strong earnings from companies like Alphabet (Google's parent company) and Nvidia propelled tech stocks upward. Alphabet reported robust first-quarter earnings, attributing its performance to increased use of its AI tools. Nvidia's shares rose over 4%. ​WSJ

Tesla's Surge: Tesla's stock climbed 9.8% on Friday, outperforming competitors, amid positive developments in self-driving technology deployment. ​Investor's Business Daily

Trade Policy Developments: President Trump's softened stance on tariffs and ongoing negotiations with China contributed to market optimism. However, uncertainty remains, as substantial concessions are still required for a trade deal. ​WSJ

Consumer Sentiment: The University of Michigan's consumer sentiment index declined by 8% from March, indicating growing concerns among consumers. ​WSJ

Gold Prices: Gold prices dropped below $3,300 per ounce, leading to losses in gold mining stocks. ​Investor's Business Daily

Market declines come in all shapes and sizes, but they tend to follow similar patterns over time. Corrections are short, sharp declines between -10% and -20%, while bear markets are declines greater than 20% that fall into one of three categories:

Structural – These bear markets are caused by severe dislocations, typically in financial markets, and are often associated with ‘bubbles.’ The 2008 Global Financial Crisis is an example of a structural bear, which often take several years to fully recover from.

Cyclical – These bear markets are more closely tied to the business cycle, and often coincide with a peak in profit margins, rising interest rates, elevated inflation, and/or a deceleration in economic growth.

Event-Driven – Event-driven bear markets are triggered by an extraneous, usually unexpected shock. The Covid-19 pandemic is a perfect example of an event-driven bear market, as investors quickly anticipate immediate and elevated risks to earnings and growth.

In terms of magnitude and duration, structural bear markets tend to be the most painful. They’ve averaged about -37% declines over approximately 42 months. Cyclical and event-driven bear markets, on the other hand, average about -30% declines over generally shorter periods. Cyclical bears have lasted 25 months on average, while event-driven bears have usually spanned about 8 months with an average drawdown of -29%.

In Mitch Zacks’ view, portfolio manager at Zacks Investment Management, the current environment has the markings of a correction or an event-driven bear market.

The stock market appears to be very quickly pricing-in uncertainty tied to tariffs and other political factors, which has led to multiple contractions even as earnings have, to date, held up reasonably well. Mitch does not see any signs of a bubble bursting or a crisis in financial markets, which I think easily rules out a structural bear.

A cyclical bear market does not seem likely either, as interest rates and inflation peaked some time ago and earnings expectations for 2025 were nicely positive throughout Q1.

Higher-than-expected tariff pronouncements—with all the accompanying uncertainty—have been the wild card, which I think puts this downdraft in the event-driven category.

Event-driven bear markets can sometimes have the look and feel of corrections, given the very short time frame where downside volatility is experienced. Once the downdraft is over, the forward returns are unanimously positive

It makes sense why the recovery from event-driven downdrafts is often quick. In many cases, the global/U.S. economy is in decent or good shape before an exogenous event takes place, meaning that it does not take quite as long for the economy to recover once the impact of the ‘event’ fades.

In the current environment, if trade uncertainty suddenly fades it would be easy to envision the market taking off in response. U.S. household and corporate balance sheets are strong, the jobs market remains in strong overall shape, and credit spreads are tight. Investment-grade corporations still have relatively easy access to capital markets, and banks are also very well capitalized. This calls for patience, in my view.

Things have gotten crazy in the normally staid world of municipal bonds. Concern that Munis ( Municipal Bonds) might lose their crucial tax-exempt status as part of the budget process has been an unpleasant backdrop all year for investors.

Then came President Donald Trump’s “Liberation Day” tariff announcements, which rocked global markets—and sideswiped Munis. At first, yields fell as investors saw Munis as potential havens (bond yields move inversely to prices), but they quickly shot higher as Treasury yields soared on fears about U.S. stability. Stocks plummeted, and investors dumped an array of bonds, including Munis, which have long been traditional favorites of wealthy investors.

Muni exchange-traded funds, which have three times the assets they did during the pandemic, added to the frenzy with heavy selling to meet redemptions. At the same time, tax-season selling was heating up ahead of April 15, and Muni issuers were rushing to get deals done ahead of any potential tax-policy changes, says Pat Haskell, head of the municipal bond group at BlackRock. “Those dynamics created adverse price actions,” he says, “but also opportunities.”

The $38 billion iShares National Muni Bond MUB+0.13% ETF, which tracks a Muni index, is down about 2.5% year to date, most of that lost in the past few weeks. The yield on Bloomberg’s 10-year triple-A Muni index jumped from 2.94% on April 4 to a high of 3.8% by April 9. It remains around 3.5%, for a tax-equivalent yield of nearly 6% for investors in high tax brackets. Municipal bonds are generally issued by public state and local bodies to finance operations.

Long-term Munis are especially appealing based on an after-tax comparison with Treasuries. Yields on the 30-year Muni index are now about 95% of those on 30-year Treasuries. “That means you get the benefits of tax exemption practically for free,” says Lyle Fitterer, co-manager of Baird Strategic Municipal Bond Investor fund, which earns five stars from Morningstar.

For 10-year Munis, the ratio is 80%, so essentially anyone in a tax bracket higher than 20% may benefit from owning Munis over Treasuries. “You can generate a tax-equivalent yield of 6% to 8% in a high-quality asset class,” Fitterer says. “That is pretty attractive.”

Of course, one reason yields are still elevated is because risks remain. Global markets continue to swing wildly based on fluctuating tariff policy, and Congress has hard work ahead to pass a tax package that will include cuts to offset some of the cost of extending Trump’s 2017 tax cuts. Removing tax-exemption from municipal bonds has been floated as a way to pay for those tax cuts. Interest on municipal bonds has long been exempt from federal taxes and, in some cases, from state and local taxes.

Tom Kozlik, head of municipal strategy at HilltopSecurities, put the risk that Munis would lose tax-exemption as high as 50% earlier this year. But in early April, the House of Representatives passed a budget framework that targeted $1.5 trillion in spending cuts, down from as much as $4 trillion to $10 trillion in cuts expected earlier. Now, Kozlik sees only a 10% chance of the Muni exemption being revoked, although he still believes the budget bill could include smaller changes to municipal bond tax-exemption affecting specific sectors.

He isn’t alone. “We continue to believe that if there were any changes, they would likely affect the private activity bonds issued for things like private universities, airports, and stadiums,” says Margot Kleinman, head of municipal credit research at Nuveen.

Budget cuts could also hurt Muni sectors. For example, cuts to Medicaid could have a major impact on hospital bonds, which make up about 9% of the Muni index. Craig Brandon, part of the Morgan Stanley team that manages the Eaton Vance National Municipal Income Fund, a four-star Morningstar fund, says budget processes can net surprising results in the 11th hour. “I’ve learned you never say never,” he says.

The impact of tariff policy is an overhang on Muni prices, even though municipalities aren’t directly affected by tariffs. States that derive revenue from agriculture might suffer from tariffs. Bonds to fund infrastructure projects for transportation or housing could be affected by higher materials and labor costs.

BlackRock suggests in its April Muni report that investors underweight small private colleges, “safety net” hospitals that serve a lot of Medicaid patients, senior living and long-term care facilities, and “speculative projects with weak sponsorship, unproven technology, or unsound feasibility studies.”

That sounds like a wide net, but it actually leaves the bulk of the Muni market looking quite strong. Moody’s Ratings gives 19 states triple-A grades, 28 double-A grades, and only New Jersey and Illinois get single-A (Wyoming isn’t ranked). Maryland alone has a negative outlook, while the rest have positive or stable outlooks.

Plus, municipalities have the ability to raise taxes and fees if they need to, points out Jennifer Johnston, director of municipal bond research for Franklin Templeton Fixed Income. “It’s a great time to take advantage of some of these higher rates that are suddenly available,” she says. Franklin Dynamic Municipal Bond ETF gets four stars from Morningstar and has a 4.14% current yield.

Diversification and active management from firms with Muni research teams make sense, given the intricacies of how policy changes can affect individual bonds. Investors in high-tax states may want to consider single-state funds for added tax benefit.

“The bulk of issuers are providing essential services, so they do tend to be very resilient,” says Kleinman. She says her team uses bottom-up credit analysis to find opportunities, even among lower-rated bonds. Nuveen High Yield Municipal Bond

NHMAX fund reflects that strategy. It has a trailing 12-month yield of 5.2%. For investors who want less interest rate risk, Nuveen Short Duration High Yield Municipal Bond  fund is an option. Its trailing yield is 4.74%.

The opportunity might not last that long, says Jeff Timlin, portfolio manager for tax-exempt fixed-income strategies at Sage Advisory in Austin, Texas. Unfortunately, with Munis you can get into what he calls a “negative feedback loop,” where negative returns lead to a liquidity crunch that begets more selling. “But it does stop when valuations become so attractive that buyers start to come in. Then it’s amazing how quickly things turn around.”

1) Earnings: roughly one-third of S&P 500 companies are reporting. Meta & MSFT on Wednesday, AMZN & Apple on Thursday

2) Wednesday: PCE price index

3) Follow through of SEMI’S & MAG 7

4) Friday: Jobs report

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