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Cash on the Sidelines but Think Equities are Too Rich? Consider Investment Grade Corporate Bonds

 If you are like many investors, you raised a lot of cash in your investment portfolio through the tumultuous markets of the past year.  Given that the S&P has rallied 14% YTD and over 59% since the lows in March, you may now be wondering if you missed the entry point for putting that cash to work for you.  If it’s in a money market fund or CD (or even stuck under your mattress!), it’s not doing much to help your investment portfolio or even keep up with normal levels of inflation.

Consider adding investment-grade corporate bonds to your portfolio to help boost your return. Bond spreads have contracted in recent months, but are not yet near the historical average.  In the current environment, most investment grade companies are well-suited to produce enough cash to be able to repay bondholders, even if they can’t yet generate significant top-line earnings growth.  I do believe that we have seen the end of high-profile corporate bankruptcies, yet advise staying away from issuers such as small financial institutions who may be under pressure to raise capital to stay afloat amidst rising loan losses.

Look at current investment-grade corporate spreads versus the historical average.

IG-Spreads

 

 

 

 

 

 

 

 

 

 

Source: Barcap Indicies; Reprinted from Moody’s

While the major rally in corporate bonds is behind us, we are still at spreads that are wider than the historical average, suggesting that investment-grade issues still have room to outperform.  Given an improving credit environment and stable economic growth, corporate bonds will continue to tighten in the near-term.  Investors with cash on the sidelines or those invested in treasury bonds who can stomach a little more risk would be well-suited to reallocate those holdings to investment-grade issues.  As I mentioned earlier this week, given that yields are set to rise in the next 12 months, you would be best served sticking to shorter-dated maturities with less rate-sensitivity.

In the next few days, we’ll review some specific trade ideas to capitalize on this theme.

Position: None