Yahoo Finance Corporate Bonds Point to Continued Economic Growth
The corporate bond market has some good news for us. The economy is set to continue growing.
It's a message that is in stark contrast to the bearish sentiment that emanated from Wall Street during the first few weeks of the year, and it has implications for the type of stocks and other securities which will do well going forward.
Credit spreads are falling. The smart way to read the bond market is to look at credit spreads. They measure the amount of interest a borrower must pay over and above what the government pays to borrow. That extra is to compensate lenders for the risks of default, or nonpayment of the loan. The government can't really default -- if it runs out of cash it can always print more money.
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In the case of corporate bonds, investors are seeing lower risks ahead in the economy because the size of the spread between what the government and what corporations pay in interest has dropped dramatically since mid-February.
The Bank of America Merrill Lynch U.S/ Corporate BBB Option-Adjusted Spread, which measures the borrowing costs of credit-worthy corporations, fell to 2.07 percentage points April 26, down from 3.03 percentage points on Feb. 11, according to data from the Federal Reserve Bank of St. Louis.
Lenders are willing to accept a lower credit spread to lend to so-called investment-grade creditors in April than they were a few weeks ago. Investment-grade securities are considered low-risk investments compared to most stocks.
Why are the spreads falling? "We are getting back to the idea that growth and inflation are reappearing," says Peter Tchir, managing director of macro strategies at Brean Capital in New York.
To turn that around, growth hasn't stalled and isn't projected to dip below zero, which was the worry of at least some investors as we began the year. The worry was real because recent data showed that the U.S. economy grew a paltry 0.5 percent in the first quarter.
But that's in the past and long gone in the minds of the many investors who try to anticipate what is going to happen in the future rather than dwell on the past. That future is looking brighter than it did a few weeks ago, Tchir says.
Some are urging caution. Not everyone agrees that the bond market has a positive message, or even any message.
"It's hard to say what it's telling us because of the distortions in the market," says Vinny Catalano, global investment strategist at Blue Marble Research in New York.
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The Federal Reserve, which keeps a close eye on the economy, has kept interest rates low for years and has implemented the so-called quantitative easing program, which involved buying trillions of dollars of bonds.
As a result, interest rates in the government bond market have fallen to artificially low levels, less than 2 percent interest a year for investing in a 10-year Treasury. Catalano says that bond market investors are buying riskier assets in the pursuit of better yields.
"They are driven into lower-quality, higher-risk investments," he says.
How to invest. Art Hogan, chief market strategist and director of research at Wunderlich Securities in New York, agrees that there has been a search for yield that has created danger in some types of securities.
But he says that the improving sentiment among bond investors is a good sign for the economy.
What's happening now is that investors are looking for riskier opportunities in the energy sector and industrial stocks, such Exxon Mobil Corp. (XOM) and U. S. Steel Corp. (X). Such stocks are highly sensitive to the economy cycle.
The appetite for taking on extra risk is in sharp contrast to the situation in the first quarter, when investors sought safety in so-called defensive stocks such as utilities, consumer staples and telecommunication companies. He calls these the "dividend darlings" on account of the high payouts the companies were making relative to other stocks. AT&T (T) has a dividend of 5 percent, for instance.
The changing sentiment doesn't just affect stocks. The increased risk appetite means that corporate bonds will tend to outperform government securities.
Tchir says investment-grade corporate bonds should do as well as so-called leveraged loans, which have variable interest rates. Both types of securities should continue to benefit from the drop in credit spreads.
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Investors looking to alter their bond allocation might want to take a look at the PIMCO Investment Grade Corporate Bond exchange-traded fund (CORP), which holds a basket of corporate fixed-income securities, or alternatively the SPDR Blackstone/GSO Senior Loan ETF (SRLN), which holds a basket of floating-rate loans and some corporate bonds). They have annual expenses of 0.2 percent ($20 per $10,000 invested annually) and 0.7 percent, respectively.
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