Time to Switch from Corporate Bonds to Equities?

To the extent that every year is characterized by “the trade”, that investment which returned the most with seemingly little risk had you only had today’s newspaper on January 1st, so far in 2009 it would have to be corporate debt.

The CDX Investment Grade index started the year at 198bps, rose to 262bps on 3/9 and closed last night at 96bps after hitting its low for the year on 9/22 at 91bps. On the Hi Yield index, the shape of the graph is the same but the levels are 1154bps on 1/1, 1925bps on 3/9, 625bps on 9/22 and 638bps last night.

Spreads, as we know (just nod yes), are only half the equation in the corporate debt market as what goes on with the risk free rate curve also affects the price of the bond; but here too “the trade” was helped by Ben buying almost everything that first Hank and then Tim issued that the Chinese and Japanese et. al. didn’t, keeping the rate base as low as possible.

As with all trades timing is of the essence and with one more ¼ left in ’09, there is still too much going on to kick back, rest those Lucchese’s on the desk and start puffing one Fidel’s finest.

Larry Kantor, who heads research for Barclays Capital, is going so far as to recommend investors begin to favor equities over corporates at this point as he feels stocks will benefit more from GDP growth and that “markets are more vulnerable to policy tightening than to growth disappointment.” “If a strong recovery becomes consensus, investors may conclude the stimuli are no longer appropriate and start pricing in tightening,” he says. An interesting statement when almost everyone else in the world seems to be able to focus on little else except that stocks have run so far so fast.

The spreads available in the corporate debt market earlier this year were the result of both the cash hoarding that was going on and a belief that defaults would rise to levels above those seen during the Great Depression. William H. Cunningham, global head of credit strategies at State Street Global Advisors, says that in looking back it was probably more the “dislocation and illiquidity of the bond market, not necessarily the deterioration in the creditworthiness of those companies,” that was the major culprit. In either case, spreads were fat and now, relatively speaking of course, they are thin.

Also on the side of stocks is David Darst, chief investment strategist at Morgan Stanley Smith Barney who said, while speaking at the 5th Annual Barron’s Winners Circle conference for top advisors: “It is not over for the United States of America.” David believes “we are in a powerful two-to-three year rally” and while it is not “the start of a secular bull market” there is a 65% chance that the results of the stimulus package, an economic recovery and plenty of cash on the sidelines, could push the S&P to 1100-1150 by year end and 1300 a year after that. One man’s opinion, yes, but that’s half of what it takes to make a market.

Enjoy the week.

Comments

[coldcall:]

Its amazing the amount of articles encouraging people to move from high grade bonds to equities. An avalanche of them!

Sep 29 09:27 AM

[User 437410:]

Is this a good time to buy some US TIPS at auction, and to sell off my position in the ETF?
Where can I find info on the 10 year vs TIPs spread? I assume to buy at the minimum spread, so am paying less for the protection?

Sep 29 01:42 PM

[Larry House:]

I don't favor a switch, but I do think bonds are fully valued now and carry increased risk of rising interest rates and inflation. If one keeps bond maturities short and can hold to maturity, the risks are greatly reduced.

Sep 29 02:46 PM

[Emerald:]

Yes, everyone should sell their bonds and buy stocks at the top! Forget that we are in a deflaionary environment and the Fed is still keeping monetary policy loose. What a great way to lose money. We will see a 5% retracement in the fouth quarter and then a slow build in the S&P thrpough most of 2010. Bond spreads have tightened but will produce comparable total returns to stocks in 2010. keep average bond duration under six years and you will do fine.

Sep 30 11:18 AM