Corporate Bonds Look Tempting

Corporate bonds are looking like bargains as a result of record tumbles in prices this year. Spreads over government bonds have also widen to record levels. Of note:

• Baa-rated corporate bonds in the U.S. yield close to 8% and recently reached a record spread of 5.5% over 10-year Treasuries, far surpassing the previous high of 4% set in November of 1982 (series goes back to 1962)
• junk bonds in the U.S. are having their worse year in history with a drop in price of about 25%; they now trade with an average yield around 19%, for a 1,5000 basis-point premium over 10-year Treasury notes.

Of course, corporate-bond defaults are poised to ramp up as the recession deepens. Currently near a 3.5% rate for U.S. corporations, the defaults are likely on their way up to the historical norm of 8% to 10% for recessions – if not beyond.

But one could argue that the stunning drops seen in corporate bond prices this year have pretty well discounted the specter of rising defaults. Or, if an investor is more of a conservative type, they could watch the bonds carefully and jump in buying on the dip that occurs when the first big defaults hit the headlines. By the way, previous downturns in 2002 and 1990 in corporate bonds were followed by gains of 28% and 39% the next year, noted Barron’s recently in an article.

Exchange-traded funds (ETFs) covering this sector include:

• iShares iBoxx $ High Yield Corporate Bonds (HYG)
• SPDR Lehman High Yield Bond (JNK)
• iShares iBoxx $ Investment Grade Corporate Bonds (LQD)
• PowerShares High Yield Corporate Bond Portfolio (PHB)

Comments

[swygert@law...:]

Though junk bonds seem attrative, no one knows how deep or long the recession (posssible depression) might last. But, tripple or double A-rated, non-callable corporate bonds, two to five years duration with YTM of between six and eight percent (e.g., G.E. bonds and notes) seem to me to represent an excellent conservative investment for an investor rather than a trader or speculator. They have little default risk while delivering a very decent return, far better than government bonds. Moreover, if two to five years from now inflation swings in and bond values drop as coupon rates rise, the proceeds upon maturity can be reinvested into higher-return bonds. I believe this is an excellent, conservative and safe strategy for those who are, or about to be, retired.

2008 Oct 31 10:11 AM

[swygert@law...:]

I should have added in my above comment that the bond strategy I suggested applies best, of course, to tax-deferred IRAs, etc.

2008 Oct 31 11:40 AM

[bnjo:]

bocaj21 can you recomand an etf tracking your comment above?

thanks

2008 Nov 05 02:13 PM

[stockman:]

Also of note is that investment grade corp bonds tend to out perform stocks in the 2 years following jumps of at least 1% year/year in BAA yield.

2008 Nov 15 01:45 PM