This week’s Barron’s has another article touting corporate bonds, but warns that investors have started to move on the opportunity. In a story in November, Barron’s claimed that “the stock market is priced for recession but the corporate bond market is priced for a depression, which implied debt offered greater potential rewards, and with less risk.”
Prices have risen in the last 6 weeks, lowering yields, as investors have starting trickling back into corporates. Nevertheless, “corporate bonds’ spread — the extra yield investors demand to compensate for risk — has remained near the peaks of the 1930s. The question is whether corporate defaults will equal those the Great Depression.”
The narrowing swap spread is a harbinger of further contraction in corporate bond spreads, according to Michael T. Darda, chief economist of MKM Partners and an early bull on Baa corporates at their peak yields in October. He sees further price gains (and yield declines) ahead. Darda notes that corporate bond yields peaked 17 months before the economy bottomed in the last cycle. That would be consistent with his forecast of a recovery coming not until late 2009 or 2010. Junk bond yields topped out 11 months before the economy’s trough, so there’s still time to buy speculative-grade debt by that schedule.
Similarly, Jeffrey Rosenberg, head of credit research at Banc of America Securities, also thinks high-grade corporates yielding over 8% offer return potential that’s competitive with equities, but with lower risk. He also favors sticking with investment-grade bonds until the default picture in leveraged finance becomes clearer-before being tempted by 22% yields on junk debt.
A “contraction in corporate bond spreads” means that prices will continue to rise. Investors who get in now may be able to lock in yields that offer equity-like returns while also benefiting from the potential for price appreciation. The potential for an excellent “total return” opportunity if we assume that the economy does not continue to contract into a Great Depression-like condition.