PIMCO's Kiesel: Three Reasons to Buy High-Grade Corporate Bonds Now

PIMCO managing director Mark Kiesel on the biggest opportunity he's seeing in this credit market:

We’re seeing the most attractive opportunities in high-quality, senior, investment grade corporate bonds. There are three reasons we think it’s a good time to own select investment grade credits: first, we believe valuations are attractive for selective companies on both an absolute and relative basis. Second, we see opportunities in key areas of the market that should benefit from aggressive policy support. Third, we believe increased global government bond issuance and spending should support selective credit investments as investors allocate out of government bonds and into higher-yielding, high-quality corporate bonds.

The U.S. government – through Treasury, Federal Reserve and FDIC programs – is ‘pedal to the metal’ with fiscal stimulus as well as direct support for certain companies and industries. These types of policy moves are not limited to the U.S. – central banks and governments around the world are aggressively expanding their balance sheets as they buy assets and support the flow of credit to the private sector.

Q: Why is now a good time to buy high-quality credit?
Kiesel: In terms of valuation, investment-grade credit spreads are currently at or near their widest levels in decades, and in some sectors they are approaching the widest since the Great Depression. This asset class has not been so attractively valued in a very long time. Additionally, we think yields at or around 7% to 8% on investment grade corporate debt look particularly compelling because we believe equity returns will be low over the next several years. In addition, Treasury yields are now near historical lows (see chart). Given the current economic environment, we expect corporate profits to grow at roughly the same pace as nominal gross domestic product (GDP), which we expect to remain weak and below trend. And dividends, currently around 3.5%, may get cut, rendering the equity market far less attractive than investment-grade corporate bonds.

This disparity between our expectations for high-quality credit versus equity is interesting, because it implies that an investor can go up in the capital structure by owning senior bonds, and get higher return potential than equity holders are getting at the bottom of the capital structure. Yet, corporate bonds, because of their seniority in the capital structure, generally have significantly less risk (and volatility) than equity holders. The current risk/reward makes high-quality corporate bonds a particularly attractive alternative to stocks.

Read the full interview.

Comments

[Steve in TN:]

The ETF that most mirrors the author's recommendation for corporate bonds is LQD. Unfortunately, this bond ETF is long-term in duration. I wish there were a corp. bond ETF that was short or intermediate term in nature. If any reader knows of a good short or intermediate term low-expense bond mutual fund please comment on it.

Apr 13 11:05 AM

[sr9web:]

I've got LQD on my watch list to see if we get another LQD price collpase like Oct 08. This ETF rarely spikes down badly, but when it does, buying it is a sure winner.


On Apr 13 11:05 AM Steve in TN wrote:

> The ETF that most mirrors the author's recommendation for corporate
> bonds is LQD. Unfortunately, this bond ETF is long-term in duration.
> I wish there were a corp. bond ETF that was short or intermediate
> term in nature. If any reader knows of a good short or intermediate
> term low-expense bond mutual fund please comment on it.

Apr 13 01:04 PM

[whidbey:]

Look at AGG and BND as less than pure plays, but probably satisfactory substitutes for those seeking to "go with the flow" on Treasury and Fed buying of bonds.

Apr 13 07:13 PM

[Indexor:]

Steve in TN

Here are a few credit ETFs with shorter maturities to look over

CSJ - iShares Barclays 1-3 Year Credit Bond ETF

CIU - iShares Barclays Intermediate Credit Bond ETF

CFT - iShares Barclays Credit Bond ETF

Apr 14 09:32 AM

[gjg49:]

you might look at BIV--vanguard's intermediate term bond ETF. duration and average maturity both in the 7 yr range.

Apr 14 10:05 AM

[JohnB:]

On Apr 13 11:05 AM Steve in TN wrote:

> The ETF that most mirrors the author's recommendation for corporate
> bonds is LQD. Unfortunately, this bond ETF is long-term in duration.
> I wish there were a corp. bond ETF that was short or intermediate
> term in nature. If any reader knows of a good short or intermediate
> term low-expense bond mutual fund please comment on it.

Not an ETF, but a Mutual Fund exactly targeted at corporates:

Vanguard Intermediate-Term Investment-Grade Fund Investor Shares (VFICX)

personal.vanguard.com/...
Expense ratio 0.21% !

Apr 14 12:00 PM

[Chris B:]

Would you have made the following investment plan a year ago?

I'll jump out of stocks and get into bonds IF stocks go down. Then I'll jump back into stocks in a couple years IF they go up.

Of course not. How about this one instead?

I'll jump into stocks when they get cheap, buy up a few irrationally discounted shares at low P/E's and ride them up into the recovery. After 1-2 years, I will have enjoyed massive gains. By then, interest rates and inflation will be on the rise. I'll switch into bond ETFs at low prices after the fed has raised rates to deal with the risk of high inflation.

As you can see, this is a buy-high, sell-low decision.

Apr 14 03:15 PM

[donzelion:]

Concur with Chris B: (all other things equal) in general, the time to buy corporate bonds is when they are cheap relative to other asset classes, not when they are expensive.

But all other things are never equal: so investors should stick with their personal asset allocation strategy, rather than chasing the hot new opportunities.

My personal asset allocation strategy seeks both an 80/20 equities/bonds asset mix and high tax efficiency. 100% of my IRA goes into bonds each year, split evenly among BND, TIP, LQD, and JNK; the remainder goes into equities until I reach the 80% target. If stock values are too high, I buy munis to bring the balance back into kilter - but otherwise, I just pass on them.

Apr 15 04:45 AM

[Righteous Dude:]

With the top-down P/E on the S&P500 around 26 or 27, it is far from obvious that stocks are "cheap". While we all know the "P" of stocks, the "E" part is a little dicey. Last year's earnings are not very helpful considering the dominance of financing companies in the S&P -- which will all see lower earnings this year.

And as for forward looking earnings !!! Fool me once, shame on you -- fool me over and over again... What fool would possibly put any weight behind Wall Street's earnings estimates? These guys couldn't even predict the downfall of their own employers.

Last year, corporate profit margins (as a percent of GDP) were at an all time high. Taxes are going up, the economy is shrinking, labor wants to restore its "share" of the pie. Corporate profit margins are likely to revert (lower) to their long term historical mean. Those margins will be applied to a smaller economy (its the recession, stupid!)

All in, the forward P/E on stocks is in the mid to upper 20s. With Treasury interest rates low, this may be appropriate (depending on your view)... but stocks are clearly not "cheap" by historical standards. At best, stocks are fair priced -- at worst, they have further to fall.

Assuming inflation picks up going forward -- history suggests that stocks will see PE compression. This happened back in the 1970s. The opposite (PE expansion) happened from 1982-2000 as inflation moderated.

Likely PE compression is another reason to be worried about stocks in the next few years. Even assuming earnings recover (which is not guaranteed) -- PE compression could mean no price appreciation.

Long term, stocks return about 6.95% (average from 1950-2000). With IG corporates yielding almost that, bonds stand a good chance of matching and possibly outperforming stocks over the next 4-5 years



On Apr 14 03:15 PM Chris B wrote:

> Would you have made the following investment plan a year ago?
>
> I'll jump out of stocks and get into bonds IF stocks go down. Then
> I'll jump back into stocks in a couple years IF they go up.
>
> Of course not. How about this one instead?
>
> I'll jump into stocks when they get cheap, buy up a few irrationally
> discounted shares at low P/E's and ride them up into the recovery.
> After 1-2 years, I will have enjoyed massive gains. By then, interest
> rates and inflation will be on the rise. I'll switch into bond ETFs
> at low prices after the fed has raised rates to deal with the risk
> of high inflation.
>
> As you can see, this is a buy-high, sell-low decision.

May 17 09:35 PM