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Stock swings are no match for bond boom

CBOE traders
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People complaining about how risky the stock market is ought to take a look at the so-called safety of today's bond market.

An aging population, an institutional aversion to the volatility of stocks (which are often said to already be trading at "fully valued" levels), and the persistent bearishness of most investors on the "macro" economy have all combined since the 2007-08 financial crisis to push a global wave of money that otherwise might purchase stocks into bonds instead.


Shopping spree

The safest bonds — those backed by a stable enough currency and a government printing press — are trading at prices so high that investors, even after pocketing the periodic payouts, are losing money on them. So Japan's bonds out to 20 years now carry a negative yield, part of the more than $11 trillion in sovereign bonds globally in negative yield territory, according to Fitch.

Of course, the negative yield assumes the bondholders aren't actually profiting by flipping the bonds to someone else later for a higher price — a tactic which in fact has worked out quite well in recent years as global yields just keep dropping, and bond prices, which move inversely, keep rising.

And that's not just happening with government bonds. Corporate bonds, which rely on a far less secure cash stream, are trading at eye-popping levels now, too.

Bonds issued by Anadarko Petroleum in March at par, or 100, with a coupon of about 5.5 percent, maturing in a decade, traded Tuesday at 111.8 cents on the dollar, as noted by The Wall Street Journal.

Similar bonds issued by the oil and gas company were trading around 77 on the dollar in February, according to Brian Reynolds, chief market strategist at New York-based New Albion Partners. That implied about a 50 percent chance of default, so the yield was almost 7.5 percent — comfortable enough for a speculative investor.

Now, at a price over 111, the yield has dropped to just more than 4 percent for the bonds rated a couple notches above junk, meaning "an investor would need almost everything to go right to make money," Reynolds said.

Price spikes

The same could be said of much of today's corporate bond market. Other recent standouts, according to FTN Financial's Jim Vogel, include Caterpillar bonds due in 2064 trading over 114 cents on the dollar, Mayo Clinic 2042 bonds at 115,Microsoft bonds due in 2055 going for more than 117 and Bristol-Myers Squibb 2097 bonds going for about 150.

Also remarkable was the way corporate bonds recently traded amid the panic over Britain's vote to leave the European Union. Typically in a panic, corporate bonds sell off as investors fear weaker growth, tighter financial conditions, or need liquidity.

Instead, corporate bond prices have risen since that vote, such that the yield on the Barclays aggregate investment grade index has dropped another 0.3 percentage point to below 2 percent.

"Rather than a specific bond, I would say the entire investment-grade universe is egregiously overpriced," said Reynolds. The bonds "look awful on a risk-return basis."

That's not to say parts of the stock market — like utilities, in the same grab for perceived safety and yield — aren't out of whack too. Indeed, the utility sector has quickly mushroomed into one of the market's largest.

But the same was once true of energy stocks during the commodities bubble — and the S&P 500 not only absorbed that body blow, it is on the cusp of breaking higher.

In fact, the index has returned 4.3 percent annualized since January 2000, with dividends reinvested. That period encompasses the dot-com crash, the housing crash, a global financial crisis and the commodities crash, to name a few.

The more bond prices keep surging, the likelier it may have to absorb a bond crash, too.