Thursday, March 22, 2012

Bond Outperformance May Be History

In USA Today, John Waggoner reports, "...for the last 30 years, bonds have beaten stocks, according to Ibbotson Associates, a highly respected Chicago research company. "It's hard to say that something that happens over 30 years is a fluke," says Francisco Torralba, economist at Morningstar Investment Management."  It is probably reasonable to say that the strong bond outperformance won't repeat itself over the next 30 year period.

Bond investing is going to get more challenging in the years ahead, particularly for those investors and institutions who favor Investment Grade Corporates.  Post-global meltdown, the supply of investment grade issues is smaller than in the past.  According to Moody's, bonds rated single 'A' or lower accounted for 58% of the corporate market in September 1990, whereas this below investment grade sector accounted for 73% of the corporate market in September 2010. 

Put the other way, investment grade corporates accounted for 42% of the market in September 1990, declining to 27% of the market in September 2010.  As Moody's points out, the cumulative defaults in the investment grade sector for the twenty year period ending September 2010 compared to cumulative defaults in the twenty year period ending September 1990 increased by 156 times

So, in the early stages of future market up cycles, investors can get equity-like returns in a larger below investment grade sector, recognizing that the sector has expanded because of the influx of fallen angels.

 It's also logical to expect that when the fire alarms go off in the equity casino and there are "flights to quality," that U.S. Treasuries will continue to benefit due to the immense size size, depth and liquidity of the market, especially compared to investment grade corporates. 

Those issuers remaining in the investment grade category today generally have the strongest balance sheets in recent corporate history, which is why intermediate bond funds have tilted their allocations to this sector beginning last year or before.

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