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For months, investors have been debating whether we are entering a period like the 1930s: hard times and high risks, but big rewards down the road for those who can take advantage.
In the world of corporate bonds, we are already there.
"The levels of default the market is pricing in (in investment-grade corporate bonds) haven't been seen since the Great Depression," says Todd Burchett, a member of the investment committee at Icon Advisers in Denver.
In short, this slice of the bond market is priced low, as if dozens of companies won't be able to make good on their debts, presumably because they'll go broke.
But you can find these low prices even on the gilt-edged bonds of rock-solid corporations such as General Electric (GE, news, msgs), Berkshire Hathaway (BRK.A, news, msgs) and Johnson & Johnson (JNJ, news, msgs). They're yielding nearly 5 percentage points more than Treasury bonds of comparable maturity; 2 to 3 points would be normal. You won't see those kind of returns again for a very long time -- and perhaps never again.
"The corporate marketplace is pricing in default rates several percentage points higher than we've seen in our lifetime or even the lifetime of the bond market," says Elaine Stokes, a co-manager of Loomis Sayles Bond Fund (LSBRX). "This is absolutely a buying opportunity."
The reasons are partly technical, but the bottom line is that this asset class is perhaps the most compelling investment opportunity in today's marketplace. I expect equitylike returns, well into double digits, over the next year or two. And everyday investors can easily target these bonds with mutual funds and exchange-traded funds.
"You want to look at corporate bonds," says Brian McMahon, the chief investment officer of Thornburg Investment Management and a co-manager of Thornburg Investment Income Builder Fund A (TIBAX). "You have yields on (investment-grade) bonds just below 9%, and those yields look pretty good right now."
I have a feeling a lot of us will be happy earning 9% over the next couple of years.
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Prices tumble on fright
October is often a terrible time for equities, and October 2008 was the worst since 1987. The price of one of the purest ways to play corporate bonds, iShares iBoxx $ Investment Grade Corporate Bond (LQD, news, msgs), an exchange-traded fund, tumbled 12.9%. Stocks went down, too, but only about a quarter more. That left bonds looking more attractive because they're much, much more secure.One big reason: If a company does go broke, bondholders get paid before stockholders.
And the truth is that even in this lagging economy, major U.S. companies are not about to go bankrupt en masse. "Corporations are much more levered outside the United States than inside the United States," McMahon notes.
In Europe, the debt-to-equity ratio averages 75%; in Japan, it's more than 90%. In the U.S., it's only 40%. "The aggregate corporate balance sheet is in pretty decent shape" in this country, McMahon says.
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The top bond fundsLawrence Jones of Morningstar discusses some of the category's best-performing funds.
But despite this, prices on investment-grade bonds have been driven to historic lows, partly because of massive redemptions at hedge funds, which ran short on liquid assets and had to sell the corporate bonds they owned to repay investors wanting their money back.
Think of bond prices and yields as the opposite ends of a teeter-totter. Yields go up when prices go down, to the same degree. Bonds issued at 6% don't trade at face value when competing yields are 9%; their price goes down enough for the yields to rise to 9%. That's what has happened to corporate bonds.
Right now, you can buy more yield for less money. So investors stand to reap capital gains as well as dividends when prices head back up.
Continued: That could happen soon
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