Buyers' Strike in Low-Yield Corporate Debt; Goldman's Bond Forecast

Investors are starting to balk at buying more long-term corporate debt at record-low yields.

Bloomberg reports Microsoft Record-Low Coupon Punishes Investors.

Investors that helped companies from Microsoft Corp. to Wal-Mart Stores Inc. sell bonds at record-low borrowing costs are being punished on concern Federal Reserve efforts to stave off deflation will drive up yields.

�You kind of have come up to a buyers� strike or buyers� sensitivity,� in terms of low-coupon debt, said Thomas Chow, a money manager at Philadelphia-based Delaware Investments, which oversees $120 billion of fixed-income assets. �Higher yield and higher coupons offer some protection from rising rates.�

Debt from Wal-Mart, Microsoft and Coca-Cola Co. sold in the past two months with relative yields as low as 25 basis points is trailing investment-grade credit that pays an average spread of 175 basis points.

Redmond, Washington-based Microsoft�s $1 billion of 10-year, 3 percent notes have fallen 1.95 cents on the dollar from their Sept. 22 issue to 97.19 cents as of Nov. 18, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The 2 percent loss on the top-ranked debt compares with a 0.2 percent decline for investment-grade bonds since Sept. 23, Bank of America Merrill Lynch index data show.

Spreads in 2011 are likely to tighten most on debt from high-quality financials, low-quality non-financials and bonds maturing between five and seven years, Goldman strategists Charles Himmelberg, Alberto Gallo, Lotfi Karoui and Annie Chu wrote in a Nov. 19 report.

�Our rates team expects long-dated Treasuries to move higher on economic recovery, both in the U.S. and globally, and the normalization of U.S. inflation expectations, with yields on the 10-year rising to 3.3 percent by the end of 2011,� the strategists wrote. �We expect total returns on tight-spread credit to underperform accordingly, with high-quality names suffering the most.�

I would suggest the opposite of Goldman's forecast. I expect low-quality junk to get hit, perhaps seriously hit as the recovery stalls.

JNK - Lehman High Yield Bond ETF



click on chart for sharper image

The JNK ETF is a good proxy for low-quality "junk".

Nearly everyone is underestimating the likelihood of a significant selloff in corporate bonds, especially junk, not because of a strengthening economy, but because of a weakening economy and rising default risk.

Corporate bonds in general, and junk bonds in particular have been a one-way bet since mid-May. If the corporate bond market cracks, it will take the equities market down with it in a serious way.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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