The stock market may be fearing the worst for the global economy, but you won't see many tears being shed by corporate bond investors.
Even as stocks sink on worries about a double-dip recession, investment-grade corporate bonds have surged ahead, pushing yields - which move in the opposite direction to prices - to the lowest in at least 18 years.
The yield to maturity on a diversified index of investment-grade Canadian corporate bonds sank to 3.626 per cent this week, according to Bloomberg. That's down from 6.18 per cent at the height of the credit crisis, and the lowest since June, 1992, when Merrill Lynch began collecting the data. (The yield to maturity is the annualized return an investor can expect by holding a bond until it matures).
Corporate bonds are rallying for a few reasons, including falling government bond yields and tame inflation. Skittishness about the stock market has also given high-quality corporates a shot in the arm, because investors perceive the risk of bonds to be lower than that of equities.
Investor Education: Bonds
"We're in a deflationary environment. People are worried about the stock market and a double-dip. All of those things have created an environment for bonds that's very attractive to clients, and corporate bonds have historically outperformed Government of Canada bonds," said Paul Harris, partner and portfolio manager with Avenue Investment Management.
The rally in corporates has gone on longer than many observers expected, as investors flee the puny returns of government bonds for the extra yield in the corporate market. Investment-grade corporates are yielding about 144 basis points over government bonds, down from 154 in June but up from 114 in March, Bloomberg said. (A basis point is 1/100th of a percentage point.)
On an absolute basis, however, corporate bond yields have come down sharply.
"I've had people in the last two years tell me they won't buy a [corporate] bond yielding 4.5 per cent because it's not high enough. Well, those are yielding 3.5 per cent now," said Hank Cunningham, fixed-income strategist and investment adviser at Odlum Brown.
Corporate bonds carry more risk than government bonds, but it's a tradeoff that many investors are willing to accept. Companies fortified their balance sheets over the last couple of years and are carrying large amounts of cash, making their bonds more attractive to risk-averse investors who were burned by stocks during the financial meltdown.
"The corporate sector, particularly in the United States, geared up for a depression, not a recession," Mr. Cunningham said. "They strengthened their balance sheets to the point where they … have adequate liquidity on hand to weather any storm."
Canadian companies issued $8.73-billion of bonds through the first seven weeks of the third quarter, double the amount in the same period a year earlier, according to Bloomberg. With yields at the lowest in nearly two decades, that trend will likely continue, he said.
"I think we're going to see a huge issuance of corporate bonds."
The runup in corporate bonds is reflected in the performance of the iShares DEX All Corporate Bond Index Fund. The exchange-traded fund, which invests in investment-grade Canadian corporate bonds, posted a total return of 5.8 per cent year-to-date, compared with a total return of 0.9 per cent for the S&P/TSX composite index.
The yield to maturity on a diversified index of investment-grade Canadian corporate bonds this week, the lowest in at least 18 years.
The average number of basis points higher investment-grade corporates are yielding than government bonds.
The value of bonds issued by Canadian companies issued in he first seven weeks of the third quarter, double the amount in the same period a year earlier.