Where the Bull Will Run in 2009

With the stock market on track to lose nearly 40% of its value this year, everybody's hoping for a strong rebound in stocks during 2009. But some see even more promise in a different market entirely -- and with nearly everyone having left it for dead, this asset class could easily leave stocks in the dust.

Corporate bonds typically don't generate much excitement among investors. For years, they sleepily delivered returns that were somewhat higher than safer bonds like Treasuries. And although the occasional company ran into trouble, a strong economy and easily available credit generally kept most debt-issuing companies healthy enough for bond investors to earn steady income.

All that came crashing down in 2008, as the credit crisis took hold and clamped down on corporate access to financing. With bond investors seemingly unwilling to settle for anything less than the complete safety of Treasuries, corporate bond yields have gone through the roof, sending prices plummeting and investors scurrying for cover.

What's down with 2008?
There's no shortage of good reasons for the current disparity in the bond market between Treasuries and less secure debt. Although the federal government continues to spend money at an unprecedented rate in its bailout efforts, demand for Treasuries has overwhelmed the expanded supply. Meanwhile, the oncoming recession makes it far more uncertain that businesses will be able to support their debt payments equally well.

Moreover, while the threat of deflation has supported Treasuries despite their current low interest rates, businesses that issue debt would be among those hardest hit if deflation were to take hold within the economy. Until the country's economic problems resolve themselves, corporate bonds will face an uphill battle.

Why 2009 will change all that
Yet it's exactly those signs of improvement that will make 2009 a much better year for the corporate bond market. Specifically, expect to see the following:

  • Treasuries lose their ascendancy. Face it: With Treasury bonds trading at such high prices, there's little room for them to rise further. Although institutions are struggling to find a new equilibrium after the financial crisis forced them to curb their use of leverage, the attractive spreads on corporate and municipal debt compared to Treasuries can't survive in the long run. Just look at some of the rates available today:

Bond Issuer

Maturity Date

Yield to Maturity

Yield On Comparable Treasury

Bank of America (NYSE: BAC  )

10/2010

4.43%

0.62%

Qwest (NYSE: Q  )

2/2014

20.40%

1.09%

Citigroup (NYSE: C  )

8/2036

7.18%

2.60%

Rio Tinto (NYSE: RTP  )

7/2013

12.66%

1.10%

United Technologies (NYSE: UTX  )

2/2019

5.23%

2.57%

AstraZeneca (NYSE: AZN  )

9/2037

5.47%

2.56%

McDonald's (NYSE: MCD  )

10/2017

4.43%

2.08%

Source: InvestinginBonds.com, WSJ. Corporate bond quotes based on latest trades from Dec. 18.

Either Treasuries will end their bull run and correct sharply, or high rates on corporate debt will attract investors with at least some appetite for risk.

  • A floor under the bad news. Given the tone of the markets lately, many expect a recession like no other since the Great Depression. But while there's a chance that those worst fears will come to pass, it's far more likely that the magnitude of the current downturn will fall short of those dire predictions. With many investors prepared for the worst, even the smallest piece of good news could feed on itself and trigger a move up.
  • Low expectations. To sustain higher stock prices, companies must generally generate substantial growth over time. But with many bonds trading at depressed levels, many companies would only need to tread water throughout the recession in order to service their debt and convince investors that default isn't imminent.
  • Government action. All the things described above could happen independently, but if the credit markets stay locked up, investors can expect the government to intervene further with initiatives designed to reduce unnaturally large spreads. Measures similar to the Fed's initiative on short-term commercial paper could be targeted at longer-term corporate debt, potentially giving businesses a much-needed break on interest expense and benefiting bondholders.

The significant losses we've seen in corporate bonds this year are extremely uncommon. But they've set the stage for a potentially huge rally once fears of economic armageddon pass. While you shouldn't expect to see the economy take a U-turn on Jan. 1, I think the market will start responding to signs of improvement before 2009 comes to a close.

For more on investing for 2009, read about:

Getting more income from your portfolio can make all the difference during tough times. For more on making the most from your investments, check out our Motley Fool Income Investor newsletter. With monthly recommendations and insight on income-producing investments, you can't afford to pass up our free 30-day trial offer.

Fool contributor Dan Caplinger owns shares of some corporate bond funds, but he doesn't own shares of the companies mentioned in this article. Bank of America is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy pays dividends.


Read/Post Comments (3) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 22, 2008, at 9:03 PM, herwood wrote:

    You tout the bonds of Rio Tinto and Qwest, but don't give cusips - Shwab doesn't have them in inventory. How would I go about getting those bonds?

  • Report this Comment On December 23, 2008, at 8:49 AM, tlsgoofy wrote:

    I would also be interested in more info on the Rio Tinto and Qwest bonds.

  • Report this Comment On December 23, 2008, at 9:12 AM, palaceplace wrote:

    the collapse of the chinese economy will cause a default in all commodity assets, including rio and the rest. their bonds are worthless!

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