Low Rated Investment Grade Credit Offers Best Value

The low end of investment grade credit looks to offer the best value to investors today. Spreads on Baa rated corporate bonds have blown out since the credit crisis took hold making corporate bonds look cheaper at any time since the Great Depression.

High grade corporate bonds trounced the performance of equities in the Great Depression offering an excellent lesson for today's investor. High grade issues during the Great Depression did not lose principal value on average and paid 4% to 5% in interest, according to The Great Crash and Its Aftermath written by Barry A. Wigmore. Equities, in contrast had an average loss in value 58% and a 50% reduction in dividend income.

Fast forward to today and top rated investment-grade corporate borrowers and investors are doing just fine. Issuers have been able to tap the market-- raising $304.5-billion year to date according to Dealogic, representing a 36% rise over last year before the market crash. Yield spreads on Aaa-rated debt over 10-year Treasury bonds are roughly 150 basis points higher than last year but absolute yields are lower because government bonds yields are so low.

Lower-rated investment grade bonds (Baa) have seen spreads widen out considerably more on an absolute and relative basis. Spreads on Baa corporate bonds over Aaa credits have only been this high on two prior occasions—both in the 1930s—dating back to 1915. Investors parking their money in low-yielding government debt will eventually move out the risk spectrum in search of higher yield. As they dip their toes into the pool of risk assets, they will undoubtedly start at the shallow end, and these bonds are the first place they could land.

click to enlarge

Source: U.S. Federal Reserve

Comments

[jptheman]

intersting...a few individual examples would be graet

2009 Apr 01 10:27 AM

[gordon]

I got GE Global Insurance bonds 6 months ago and FirstEnergy(FE) at $97 (discount) maturing 2010-11 paying 7-71/2% non-callables. I don't see anything close to that now. It's too late. Everything offered (in my 401K, I have to use Ameritrade) is going out to 2013 for 5% or so, that's nuts. Municipals are even more overvalued, all $109 , a huge premium to earn 3%. This call is too late, by 6 months unless you want Cox Communications, or similar risky company. All the goon-heads recommending municipals now are just that, on tv. Smart money bought them over a year ago.

2009 Apr 01 11:37 AM

[User 388056]

I agree that more examples should be provided.

The time has come to ignore the talking heads with their scattershot predictions and work with Megatrends based on sound economic fundamentals:

Inflation (Govt strategy)
Need to boost house prices -- print more money! Need to reduce govt debt -- print more money. Need to cut worker pay to compete - print more money -- all equal Inflation -- killer for bonds.

I have bot more bonds than stocks through the years so I can say without bias that bonds yielding less than 6% (treasury, municipal, AAA corp etc.) are only a short term holding/park your money strategy - you will need to get out quickly if you can time it right. Otherwise, the interest rate risk is not worth the current income paid for these low-yielding bonds.

Consider CNP stock @ $10/share - pays 7.5% div, earns a stable $1.25/yr, meaning return on your equity is 12%. This is a monopoly since Centerpoint is the wires utility for Houston & the natural gas supplier as well. Easier to trade than bonds and max tax rate on your dividends is 15%. Plus, inflation hedge as CNP holds mostly hard assets that will not be obsolete.

2009 Apr 03 08:13 AM