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Weekend reading: Beware of bonds edition

Money articles

My weekly commentary followed by my weekend news and blog links round-up.

Back in January 2009, I wrote how it could be time to invest in corporate bonds, saying:

To cut to the chase, I think if you’re ever going to add corporate bonds to your portfolio, circumstances such as those following a panicked credit crisis may offer a window. The extreme fear in the market creates imperfect pricing, and so opportunities for the brave.

This turned out to be a good observation, not to blow my own trumpet (always painful!)

Some UK corporate bond funds are up 40% since March and it’s been the same story in the US. The Telegraph said last week that:

Corporate bonds have seen the most explosive rally in nearly a hundred years since the markets touched bottom last winter.

Morgan Stanley said none of the previous bond recoveries going back to 1925 had been as dramatic as this.

“Credit rallies are historically fast and fierce, but this one has become unusually rapid. Levels are almost back to where they were in the first quarter of 2008, but equities are still a long way off that.”

The question is should investors still be chasing corporate bonds?

The Morgan Stanley research quoted by The Telegraph suggests not, implying the rally has come too far, too fast to be rational, and pointing out that even after the recent gains in equities, shares look much cheaper:

Analysts say the current dividend yield on the German utility RWE is 7.7pc while the interest return on a five-year bond issued by RWE is 3.2pc, and the credit default swaps have dropped to just 50 basis points.

These markets are clearly out of alignment. They appear to be reflecting an assumption of a prolonged ‘bond-friendly’ form of gentle deflation, which is at odds with assumptions in the rest of the market.

In other words, it’s not that corporate bonds shouldn’t have recovered after all the money governments have thrown at the credit markets — but rather that the summer rally in shares should have gone further, too, if the bond rally is rational.

The risk is that it’s not — that measures like quantitative easing are fueling irrational euphoria in the credit markets.

Regardless, private investors are still backing corporate bonds, putting more money into bond funds than into equity investment.

According to industry research for the UK:

Of the £2.3bn net retail sales in July, £829m went into bond funds, with the Sterling Corporate Bond sector taking the most with £466m, while total net equity sales were £711m.

It’s not surprising bond funds are attracting lots of interest. As well as the good returns in 2009, advertising can point to the 10-year record for corporate bonds that I finally dug up and posted this week, which shows them beating shares for a decade.

It took me months to get the data from Barclays Capital, who were presumably too busy buying Lehman Brothers and saving their bit of the market from meltdown to send me the 2008 Equity Gilt Study. So I ended up getting the new 2009 one.

Beware — that older data to year-end 2007 wouldn’t have flattered corporate bonds to anything like the same degree. The data to 2010 looks pretty secure, barring another economic panic, but at some point normality will return and equities will pull ahead again.

Some interesting financial blog posts

  • Trent has written a typically thoughtful article on The Simple Dollar asking if poor people are lazy?
  • Pension deficits aren’t just a UK problem, with US companies also facing shortfalls according to the High Yields blog.

The pick of the weekend newspapers and sites

  • The FT also flags up a first-time buyers mortgage from Halifax that requires only 10% deposit. But it charges 7.29% for three years!
  • If you’ve got your future house deposit in cash savings, check out this round up of the best fixed rates, again from the FT.
  • The Economist considers how media companies can start to charge for online information. (I’ve no plans to change for Monevator!)

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