The credit markets for both investment grade and below investment grade corporate bonds have underperformed Treasury bonds this year. The underperformance during the last four months has been significant, and it has accelerated over the past few weeks. This marks the first year in the last four years that we have seen credit underperform Government bonds. So is this the time to buy?
I think you can opportunistically add corporate bonds at these valuations. The four reasons that I am constructive on bond spreads over the next 6-9 months are: default rates remain low, access to capital for corporations is high, the Fed remains accommodative, and the need for fixed income investors to find yield persists. It is not all rosy for credit spreads, as balance sheets have been levered up over the past few years to fund share buybacks and the risk for mergers using significant leverage needs to be kept in mind.
I expect the stock market to be focused on third quarter earnings this week. I also expect earnings to be in line to slightly better than expectations. If commodity prices also continue to be strong (oil north of $50/barrel), expect stocks to remain well bid. In that type of environment we would expect 10-year treasury yields to move toward 2.25
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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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