The swift rally in stock markets this year caught everyone’s attention. But with far less fanfare, a frenzy has been taking place in the market for corporate bonds.
When credit markets practically shut down last year, businesses had to pay huge premiums to raise money from investors, offering returns of 10 to 20 percent to anyone who would buy a company’s debt. Now, investors are the ones paying higher prices as they race back into the bond markets, where companies and governments go to raise money for new projects and mergers, and to finance their daily operations.
Some see this as good news, a sign that credit markets are humming along after their near-collapse last year. Others believe Wall Street’s next big bubble is now inflating as investors chase down returns, and they warn that the big spike in bond prices could roll backward if the economy stumbles and investors again run for safer ground.
“I don’t quite see the fundamentals of how this works,” said Thomas H. Atteberry, of First Pacific Advisors. “If I don’t think I have a sustainable economic recovery, how do I justify these prices? How do I justify these yields? You go, wait a second.”
The surge back into bonds this year, from sterling triple-A securities to riskier junk notes, has amazed even longtime analysts and fund managers.
Investors who ran for the relative safety of money-market funds during last year’s credit crisis have been shoveling their cash into bond funds. Some $265 billion has flowed into bond funds since the beginning of the year, according to figures from the Investment Company Institute, 15 times the money that has entered equity funds.
“The easy trade is something you want to be wary of, and the easy trade right now is into the high-quality fixed income market,” said Lawrence Glazer, a managing partner at Mayflower Advisors. “Look at the flows: people are falling over themselves. That should be a caution flag for investors.”
A wide gauge of the market for junk bonds is up nearly 50 percent for the year, compared with a 13.5 percent yearly return for the Standard & Poor’s 500-stock index. The risk premium on junk bonds over Treasuries — called the spread — narrowed to 7.5 percentage points last week from more than 16 percentage points at the start of the year, according to Standard & Poor’s figures.
Troubled companies like casino and hotel owners, home builders, and energy producers are again able to raise money, though some are still paying double-digit interest rates to entice investors.
Corporate mergers and acquisitions are picking up. And some better-quality corporate bonds have even recovered all of their losses from the credit crisis.
“It’s been a straight line up,” said G. David MacEwen, chief investment officer for fixed income at American Century Investments. Still, he wondered: “Has it run too far, too fast? Is it priced for the economic environment we’re likely to see?”
Those questions have gotten louder as key measures of the economy and investor sentiment waver. After seven months of gains, stock markets have fallen in the last two weeks. Job losses ticked up in September, sales of previously owned homes fell back, and orders for manufactured goods slipped.
These could be nothing more than moments of pause in a long economic recovery. But if the economy slides backward, analysts worry that investors may flee for safer investments like Treasury debt or securities backed up by the United States government.
Bond buyers, especially those in riskier ventures, could see their investments decline. And companies could be forced to pay higher interest rates to take on new debt or refinance old bonds, putting more strain on their bottom lines.
In the last three months, yields on the Treasury’s benchmark 10-year note dropped from 3.54 percent to 3.22 percent, and the yield on the 30-year “long bond” fell below 4 percent last week for the first time since April. This means the government pays less to finance its record borrowing, but the bigger demand for Treasuries suggests investors are getting a bit more nervous.
Ratings downgrades have slowed this year as the credit markets healed — largely because of infusions of cash and debt guarantees from Washington — but bankruptcies and defaults still threaten bond investors.
The number of defaults worldwide has increased fourfold since last year, according to Diane Vazza, head of global fixed income research at Standard & Poor’s. And analysts say home foreclosures, credit losses and weak corporate revenue still pose a challenge to companies and the investors who own their debt.
Bond yields are still higher than their historic averages, suggesting that there is still more room for profit. But analysts say much of the easy money has already been made by investors who jumped in earlier this year, when companies were desperate to find investors.
“I use a golf analogy,” said Mark Kiesel, a managing director at Pimco. “At the start of the year, we were on a golf course where there was no rough and the fairways were wide open.”
Now, he said, the fairways have narrowed.