Written by Kevin Grewal, Editorial Director at www.SmartStops.net
NEW YORK (
) -- As companies continue to outperform Wall Street's expectations, bonds issued by non-financial companies are the most expensive they have been since the start of the credit debacle. Investors are starting to shy away from Treasuries, turning to corporate debt.
According to Bank of America Merrill Lynch Index data,
Johnson & Johnson
led a drop in U.S. industrial company debt yields to 130 basis points more than similar-maturity Treasuries. Additionally, the overall U.S. corporate bond market is up 1.3% this month and is expected to post its fourth-straight month of gains. In comparison, U.S. Treasuries have returned a mere 0.4% for the month, after witnessing a decline of nearly 0.85% the month before.
Another indicator that corporate bonds are gaining appeal is overall corporate credit risk appears to be declining. The Markit CDX North America Investment Grade Index Series 14 continues to increase as it gained 1.2 basis points, reaching a level of 89.4 yesterday.
The index is known to be used as a hedge against losses on corporate debt or a way to bet on corporate creditworthiness. Increases in the index generally indicate deterioration in investor confidence and decreases in the index indicates improving investor confidence. Overall, the consensus behind corporate debt is that it is likely to outperform credit-default swaps.
Tight spreads are another indicator that corporate bonds are healthy. In general, tight credit spreads in corporate bonds indicate increased confidence in the overall health of the issuing company. Chevron is benefiting from the recent rally as it is boasting the tightest spread amongst companies in the Bank of America Merrill Lynch industrial index.
The energy conglomerate has a spread of 1 basis point on its $1.5 billion of 3.45% notes due 2012, which were at 104.5 cents on the dollar yesterday.
Health care giant, Johnson & Johnson, is seeing a similar trend in its $600 million of 5.15% notes due 2010, which were at 18.76 cents yesterday, yielding a spread of 4 basis points.
One reason that this phenomenon is prevailing is due to the healthy first-quarter profits. Nearly 82% of the companies in the
have reported quarterly earnings that have exceeded analyst expectations. This trend in non-financial companies is likely to continue as fundamentals in various sectors are expected to continue to improve, initial jobless claims are expected to continue their decline and the overall U.S. economy continues to stabilize.
In fact, the International Monetary Fund has recently revised its GDP growth expectation for the U.S. in 2010 to 3.1%, up from its earlier expectation of 2.7% released in January; an indicator that the U.S. economy continues to gain strength, which will ultimately drive corporate profitability.
In conclusion, with President Obama proposing stricter regulations on Wall Street, worsening of the fiscal crisis in Europe and the possible threat of a downgrade in U.S. sovereign debt, corporate bonds of non-financial companies seem to be a safe haven that some investors are fleeing to.
Some ways to gain diversified exposure to corporate bonds include the following:
iShares iBoxx $ High-Yield Corporate Bond
, which has a yield of 9.32% and is up 33% over the past year. HYG closed at $88.99 on Thursday.
PowerShares High-Yield Corporate Bond ETF
, which has a yield of 8.62% and has gained 27.5% over the past year. PHB closed at $18.11 on Thursday.
Corporate bonds seem to be presenting an opportunity, but a hiccup in the economic recovery could potentially hinder their performance. To help protect against this risk, the use of an exit strategy that triggers price points at which an upward trend in the mentioned bond ETFs could come to an end is of importance.
According to the latest data at
, these price points are: HYG at $86.44 and PHB at $16.86. These price points change on a daily basis and are reflective of market volatility and both macro and micro economic factors. Updated data can be found at www.SmartStops.net.
Written by Kevin Grewal in Laguna Niguel, Calif.
Kevin Grewal serves as the editorial director and research analyst at The ETF Institute, which is the only independent organization providing financial professionals with certification, education, and training pertaining to exchange-traded funds (ETFs). Additionally, he serves as the editorial director at SmartStops.net where he focuses on mitigating risks and implementing exit strategies to preserve equity. Prior to this, Grewal was an analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds, arbitrage mechanisms and alternative investments. He is an expert at dealing with ETFs and holds a bachelor's degree from the University of California along with a MBA from the California State University, Fullerton.