Tough Times for Corporate Bonds

First let me say that I'm not surprised the market rallied strong Wednesday. Like I said just a day earlier, we knew Countrywide (CFC) was in serious trouble. We've known this for months. Why does the market sell off 200 points on news that was widely expected? With the market taking about 2/3 of it back Thursday, I'd say that sell-off was mostly fast money driven.

That doesn't mean we won't keep going lower. As I discussed the other day, it sure seems like the corporate bond market is set up for a much worse economic outcome than the stock market. Corporate bond spreads are as wide or wider than the last 2 recessions, and yet the stock market valuations seem sanguine on the topic.

But there are some good arguments for the diversion. First of all, the corporate bond universe and the stock market universe are not the same data set. Here are the top 10 investment-grade bond issuers:

General Electric (GE)
AT&T (T)
Goldman Sachs (GS)
Citigroup (C)
Bank of America (BAC)
Morgan Stanley (MS)
JP Morgan (JPM)
AIG (AIG)
Comcast (CMCSA)
Merrill Lynch (MER)

Here is the top 10 for the S&P 500
Exxon Mobil (XOM)
General Electric
Microsoft (MSFT)
AT&T
Procter & Gamble (PG)
Chevron (CVX)
Johnson & Johnson (JNJ)
Bank of America
Altria (MO)
Pfizer (PFE)

Within the S&P 500, only GE, AT&T, and Bank of America would appear on both lists. And interestingly, among the top 10 corporate list, only AT&T's stock is closer to its 52 week high than its 52 week low.

So perhaps the divergence in corporate/stock valuations isn't so strange after all. Perhaps the kinds of companies who are large bond issuers are struggling in the stock market as well. Perhaps the kinds of companies which are keeping the stock averages afloat are not big bond issuers: XOM, MSFT, PG, etc.

We may be looking at a sort of weird recession coming up. One where layoffs aren't as bad as some past recessions, but consumer spending drops substantially anyway, because of credit availability. I could see such a recession not being terribly bad for stocks. But financials are right on the forefront of these problems. If that's how it plays out, then the financial-laden corporate bond indices will at best stay wide for a while, even if the stock market improves.