Credit positive despite stock drop-11/03/2009

Stocks just completed their first negative month since February, but returns were still positive in the corporate-bond market.

Investment-grade credit returned 0.8 percent in October, while junk bonds produced gains of 1.8 percent, according to Bank of America / Merrill Lynch. That compares with a 2 percent loss for the S&P 500 and a negative 3.44 percent reading on the iShares MSCI Emerging Markets Index (EEM) exchange-traded fund.

"Credit enjoyed another strong month in October with the lower portions of the quality spectrum outperforming, as credit investors flush with cash from the ongoing liquidity technical reached for yield," Bank of America strategists wrote in a note to institutional clients. Lower-quality assets, including distressed bonds, broadly outperformed safer instruments such as loans, according to Bank of America.

The pattern suggests that the underlying financial-recovery trend remains in place. One noteworthy piece of data from the report is that the best performance in investment grade came from distressed sectors such as financials, real-estate investment trusts, banks and insurers. This differed from equities, where the financial sector fell about 6 percent last month, triple the S&P 500's decline.

We continue to see a huge improvement in the financial market from a year ago, when banks were forced to unload large portions of their balance sheets at distressed prices. As conditions in the sector return to something approaching normality, there is less danger of the distress seen in November through March repeating itself.

More positive signs of stabilization came from Australia, where the central bank raised interest rates for the second time in a month, and the European Union raised its 2010 GDP forecast. These are not reasons to run out to buy stocks right now, but they do reflect a trend toward improvement that didn't exist 6-12 months ago.

Concrete signs of real expansion continue to trickle out of Asia, where Dealogic reports strong debt growth in countries such as India and Indonesia. These countries are still in relatively early stages of leveraging their economies, and they are spending on projects such as infrastructure that will boost real output.

The trends suggest that the emerging-market story remains on track and that years of rising incomes and asset prices will likely follow.

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