Everywhere I turn, I see headlines about the "
"The Great American Bond Bubble" -- August 18, 2010,
The Wall Street Journal
"The Unstoppable Bond Bubble" -- August 16, 2010,
Clearly, the demand for bonds has been rising -- pushing prices up
and pushing yields down. The Investment Company Institute reported
that from January 2008 through June 2010, bond funds saw an inflow
of $559 billion. Equity funds, in contrast, experienced withdrawals
of $242 billion.
But are bonds overpriced? Do they represent more risk? Are they
The chart below shows the
spread between the 10-year
and corporate bonds rated "Baa." According to Moody's, "Baa"-rated
bonds are investment-grade, but still carry moderate credit
As you can see, the difference between corporate bond yields and
Treasury note yields grew during the financial crisis. In December
2008, corporate bonds were yielding 8.4%. At the same time,
investors clamored for the safety of U.S. Treasuries. The yield on
the 10-year Treasury fell to 2.4% -- 600 basis points lower.
As the financial credit crisis improved, the yield spread narrowed.
But it still sits above pre-crisis levels. The "Baa" corporate bond
yield in August was 5.7%, just about where it was five years ago.
The yield on the 10-year Treasury, however, is 150 percentage
points lower than it was five years ago.
If I had to pick a group of bonds that may be a little pricey, it
would be U.S. government debt. I understand why investors may be
reluctant to buy equities. It takes a strong stomach and an acute
eye to withstand the rocking and rolling of the U.S. equity market
But I'm a little stymied at why investors would settle for the 2.7%
yield on a 10-Year Treasury note -- or the 0.12% yield on the
3-month Treasury bill.
Corporations are Stronger
The U.S. economic recovery may be slowing, but companies have
strong balance sheets. The non-financial companies in the S&P
500 are sitting on $837 billion in cash at last count -- which is
much higher than normal -- and +26% more than they had last year.
The default rate on even the most speculative corporate bonds has
dropped this year. In June, the ratings agency Fitch reported that
the default rate on high-yield bonds was running at a full-year
rate of roughly 1%. In 2009, the default rate for speculative bonds
Many Non-U.S. Economies Are Stronger
While U.S. economic growth could slow, other economies in the world
continue to show strength. Vietnam's
grew +6.4% in the second quarter of 2010 and could grow by +7.0%
this year. The International Monetary Fund expects India's economy
to grow +9.4% in 2010. And Chile just reported its best quarter of
economic growth in five years.
It's true, other countries are leaving the U.S. economy in the
dust, and paying our significantly higher yields on their
government debt. [Read:
How to Lock in 8% Government Yields
Action to Take -->
While U.S. debt is considered a classic safe haven, the price of
safety may have become just a little too high. There is not much
upside potential left for U.S. Treasuries. And there certainly is
little yield compensation -- especially when compared to the 8.0%
yield of the
PIMCO Corporate Income Fund (
and other bond funds.
Bonds are in demand; there is no denying it. But there are some
good reasons to like corporate and foreign debt.
Inflation is low -- increasing just +1.2% in the last 12 months.
The U.S. equity market is being stingy with returns -- the S&P
500 is up just +2% year-to-date. Many corporations and emerging
markets have healthy balance sheets, easily carrying their debt
burdens. And baby boomers are growing older, ensuring a continued
demand for fixed income securities for the foreseeable future.
-- Amy Calistri
A graduate of both Columbia University and The University of
Texas, Amy's experience includes managing $5 million in trust
funds, economic consulting and financial risk management. Read
P.S. -- Bonds are a major part of my $200,000 real-money
portfolio in The Daily Paycheck, so you know I'm not just talking
the talk -- I'm putting money where my mouth is. If you want to
learn more about The Daily Paycheck -- including the rules I use to
generate a daily stream of income, I invite you to read my free
course: 51 Dividend Checks a Month.
Disclosure: Neither Amy Calistri nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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