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Bonds' Steadiness Shows Focus on Right Numbers

Bond investors have kept their eye on the bottom line.

If Corporate America's books are such a mess, why isn't the corporate bond market crying?

Whenever stocks go down these days, invariably we're told it's because there "may be other Enrons out there." By many lights this year's listless share prices have been driven primarily by the worry that U.S. companies have played it fast and loose with their accounting.

Yet corporate bonds have fared all right. Some issues, most notably



bonds, have been hit by accounting worries, driving volatility higher. But the spread between the average corporate bond's yield and the benchmark 10-year Treasury is just about where it was when the year began, according to Moody's. Bond investors just don't seem to have got the same case of the nerves that their brethren in equity land have caught lately.

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Much of this may just be a question of experience. Miller Tabak bond strategist Tony Crescenzi notes that the bond market is dominated by institutional investors, whereas individual investors play a much larger role in the stock market. "The institutional investor tends to have a steadier hand," he says. "They have the experience of having invested at other times of uncertainty."

But the other, and perhaps more important, distinction between stock and bond investors is how they examine companies. Stock investors are concerned with growth -- a company's stock price is based on investors' perception of its ability to deliver earnings over the next several years. Bond investors' main concern is getting their money back. So when companies started offering up pro forma earnings reports, which excluded big, supposedly one-time charges, bond investors paid less attention to them than stock investors did. A write-off, in the bond market's eyes, is still a loss.

Spread between 10-year Treasury and corporate bond yields

Source: Baseline

"A lot of times bond investors are looking at the cold, hard bottom line," says Patrick Kennedy, bond portfolio manager for Pitcairn Trust. "Stock investors are trying to project more of the future."

Corporate bond investors also have a closer eye on the overall economy, says Crescenzi, and as a result are less fretful these days about companies coming up shorthanded. Recent economic reports have consistently shown an improving economy, and some economists, like Morgan Stanley's Richard Berner, are saying the recession is already over. Although some Cassandras have warned that the worries over accounting might stifle the recovery, "having walked through it, the bond market doesn't see much systemic risk," says Crescenzi.

One of the things that Enron did to stock investors was force them to take a closer look at the bottom line. When they did that, they saw that S&P 500 earnings, as tallied according to generally accepted accounting principles, came to only 58% of what the pro forma numbers showed. Old news for bond investors, but the kind of stuff that's made some stock investors blanch.

That said, Merrill Lynch chief U.S. strategist Rich Bernstein doesn't think this year's softness in stocks has done anything to resolve the glaring differences between pro forma and GAAP. "It shows you how speculative the market has got," he says. "In the quest for maximum capital appreciation, investors are not doing their homework."