Maybe questioning the stock market's big rally over the last couple of months is a foolish thing.
Markets, after all, are supposed to be better prognosticators than people are. They are a huge meeting of minds -- thousands of people stepping up to the table and throwing down their chips on what they think will happen. So while you may not believe that the economy and corporate profits are going to put on an amazing recovery next year, you should know that your opinion is at odds with the stock market.
But at least the corporate bond market is your friend.
Don't Fight the Tape
A good read on fixed-income investors' assessment of the economy comes from quality spreads -- the difference between Treasury bond yields and corporate yields. When the economy is looking good, corporate debt looks like a less-risky investment and spreads narrow. When times get tough and the possibility of defaults increase, spreads widen.
With the economy on the outs, those spreads were already wide before Sept. 11. In the three weeks that followed, they got as wide as they have been since 1982. Since then, they have contracted only marginally.
Source: Federal Reserve
"You have equities rebounding, but the quality spreads in the bond market aren't quite singing the same tune," says Bill Sterling, chief investment officer at Trilogy Advisors. "If you're not confused now, you're not paying attention."
Although there are some extraordinary factors contributing to the widening in quality spreads (like Treasuries' traditional role as a safe-haven asset), in general they are the result of the bond market's more jaundiced view of the economy, according to Raymond James chief economist Scott Brown. "Bond investors tend to be a little more conservative," he says. "They want to see some proof the economy is getting better."
They are also, says Brown, more worried than their counterparts in the equity market about what future cash flow is going to look like. With capacity still abundant and burgeoning layoffs sure to cut into demand, it will take time for companies to regain their strength. Moreover, the bond market tends toward orthodoxy when it comes to looking at corporate balance sheets, watching the actual bottom line rather than the bottom line that would have been but for the cost of doing business.
Your Friend, the Trend
That conservatism has been spot-on so far. In the past year, stocks have seen a number of rallies on the belief that everything was going to be set right "in the next six months." But while the equity market was busy betting its bottom dollar that tomorrow there'll be sun, over in corporate bond land, quality spreads steadily kept widening.
This is not to say that the corporate bond market might not have it wrong now. Even if you don't think the economy is on the brink of recovery, it's hard to believe we're in the midst of a recession as crushing as the one in 1982.
But if the corporate bond market is wrong, then maybe the message isn't that you should be buying stocks, but that you should be buying corporate bonds.
Patrick Kennedy, a bond portfolio manager at Pitcairn Trust in Jenkintown, Pa., says he has been steadily adding to corporate positions while lightening up on Treasury and mortgage-backed bonds. "You just look at these spreads," he says, "and this has to be enticing."