Corporate Bonds: A Popular Income Investment You Can Safely Ignore

by: Jim Trippon

These are go-go days for high-grade corporate bonds. For the issuers that is. The Federal Reserve's low interest rate policy has punished investors looking for yield from cash and debt instruments, but hey, if you're a company that wants to sell corporate bonds, your timing couldn't be better. What's the recipe for success for a blue-chip corporate bond issue? Take advantage of the current interest rate environment by selling bonds now and offer barely more in the way of yield than an investor would get from a CD.

It's almost as though these companies are saying to investors “Don't want the risk of stocks, but want a little more yield than CDs or Treasuries? Well, we're the only game in town.” The question income investors need to be asking is “What's the point of being involved with high-grade corporate bonds when the dividend yields from the same companies are usually better?”

Case in point: Johnson & Johnson (NYSE: JNJ). In early September, I noted that Johnson & Johnson had sold some 10-year debt in August with a yield of 2.95%. When I wrote that piece, JNJ was yielding 3.7%. The shares have moved up a bit since then, but still yield 3.4% and that's still better than the bonds.

Blue chips are bringing more debt issues to market, but investors should not be impressed. According to the Wall Street Journal, earnings season usually represents a lull in the corporate debt market, but Microsoft (NASDAQ: MSFT), PepsiCo (NYSE: PEP) and Wal-Mart (NYSE: WMT) have all sold debt in recent weeks.

Microsoft sold three-year debt with a coupon of 0.875% and five-year debt with a 1.625% coupon. The Journal said those were record low yields until Wal-Mart offered three- and five-year debt earlier this week at rates of 0.75% and 1.5%, respectively. The current yields on shares of Microsoft and Wal-Mart are 2.5% and 2.3%, respectively. Not earth-shattering, but certainly better than what the bonds will get you.

Pepsi wasn't any better, selling $2.25 billion in a three-part offering that won't get you much more than what the comparable Treasuries offer. Worse yet for those investors that feel compelled to own high-grade corporate bonds, yield on these instruments has been a multi-year tailspin as highlighted by the chart below (click to enlarge). As the chart says, corporate bond yields have only been lower than they are currently during the Great Depression. That's a startling factoid.

A Popular Income Investment You Can Safely IgnoreClick to enlarge

An extremely conservative investor could argue that returns on corporate bonds could be bolstered by reinvesting the proceeds from the shorter dated maturities, say the three-years, into the five- or 10-years, also known as laddering. That's not a terrible idea, but reinvesting stock dividends over five- and 10-year time frames would almost certainly prove to be the better strategy. Once again, dividend stocks show their value.

Disclosure: No positions