Despondent investors can find some reason for hope in the bond markets. Through unprecedented support measures, the Fed has succeeded in driving and keeping interest rates down in key credit markets (i.e. commercial paper and conforming residential mortgages). Hopefully the Term Asset Backed Securities Loan Facility (TALF) will have a similar salutary effect on the frozen/dysfunctional securitized asset markets.
While stocks have sunk to new bear market lows, investment-grade corporate bonds have retained the better part of the gains they registered off the November lows. LQD, the ETF that tracks the iBoxx Investment Grade corporate bond index, is 12% above the lows reached last fall. In contrast, high-yield bonds have behaved much more like equities of late and have given back all of the gains they registered in the bear market rally at the end of last year.
Given the exceptionally cloudy prospects for stocks, investment-grade corporate bonds are likely to attract a larger share of investors’ portfolios. The asset class offers cash yields in the mid to high single digits, depending on maturity and credit quality, and in a world of very few certainties, it seems highly likely that we will sustain a level of GDP (even if government spending has to account for an increasing share of it!) that will allow our investment-grade corporations to service their debt obligations.
Although a steep yield curve, such as we have at present, has historically preceded an economic recovery, and is an important life-support for the banking system due to the “fat” lending spreads it provides, the current 90-day T-bill rate of 0.24% is viewed as negative for stocks because it reflects the very poor economic and financial crisis the U.S. has encountered, and the unwillingness of investors to put their capital at risk. It is unlikely we will see the pre-meltdown 1.5% - 2% T-bill rates any time soon, but a move above 0.5% would be a signal that things are “on the mend.”