Once the hands-down favourites over stocks, US corporate bonds may not be such a clear-cut choice after frenzied rallies in both markets, money managers say. Though still star performers in the bond world, corporate bonds no longer sport the record high yields that made them so popular about six months ago.
The stock market, meanwhile, has staged a massive comeback since March, and more care is needed to find undervalued names that can weather a slow-growth economy, strategists said. I think you're going to see individual names become far more important," as both markets return to more normal conditions, said Stephen Wood, New York-based senior portfolio strategist at Russell Investments.
"It's going to be more a name-by-name, active management environment than it will just be a broad asset class or thematic performance." In late March, an overwhelming 67 percent of money managers surveyed by Russell Investments were bullish on corporate bonds, a higher score than any other asset class, including US large-cap equities.
Corporate bonds were seen as a solid bet because the credit crisis had punished good companies together with the bad, sending bond yields to historic highs of 9 percent or more. Amid fierce buying, those yields have dropped to about 6.5 percent, according to Bank of America Merrill Lynch data. Peter Andersen, a portfolio manager at Congress Asset Management in Boston, said it's easier to find undervalued stocks than bonds.
One draw is the attractive dividend yield on many stocks, in some cases equal to or better than a company's bond yields, he said. Dividend yields, the income paid out in dividends divided by a company's share price, soared last year as share prices fell and remain high for many names. Telecommunications firm Frontier Communications Corp has a dividend yield of 13.7 percent, better than the 10.5 percent yield on its 30-year bonds.
Tobacco company Reynolds American Inc has a dividend yield of 8.6 percent, versus 7.8 percent for its bonds due in 2017. "You're getting more income buying the stock than buying the bond, and you also have potential upside on the capital appreciation," Andersen said. Barry Knapp, head of US equity portfolio strategy at Barclays Capital, said corporate bonds are still an obvious choice over equities in the financial sector, though in other industries, the argument is not so strong.
Recent equity-raisings by financial firms will protect the credit part of their capital structures, "so there's probably still room within that sector in particular for credit to outperform," he said. The earnings outlook for financial stocks, he added, is not very good until 2011 at the earliest.
Both stocks and corporate bonds face hurdles. Even when the recession ends, profits are expected to be anemic, ongoing real estate losses will leave more bad debts to be mopped up, and a selloff in US Treasuries is pushing interest rates higher. Weak profit growth is not as worrisome in the bond market if companies can at least survive to pay off their debt, some money managers say.
To be a solid bet for bondholders, "companies only have to stay in business, they don't have to make money for their shareholders," said Keith Springer, president of Sacramento-based Capital Financial Advisory Services. He especially likes bonds of companies getting government support, figuring risks are minimal with the government as a partner. Some GMAC bonds he bought a few weeks ago, for example, have rallied 10 to 15 percent, he said.
Sue Stevens, president of Stevens Wealth Management in Deerfield, Illinois, said stocks are in a secular, or long-term, bear market. Stevens is putting more money into bonds but limiting her corporate bond exposure to very high-quality issues. "I think people are a little too optimistic at the moment about recovery," she said. "If you're trying to balance risk and reward, I would be careful about getting too far on the risk side of things.
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