Corporate Bond Sales Collapse, Corporates on Pace for Worst Monthly Returns Since October 2008

Bernanke's QE II policy did nothing for jobs, nothing for bank lending, nothing for the real economy and had negative benefits for small businesses. However, the Fed did ignite a rally in the stock market and corporate bonds.

That corporate bond story now shows signs of unraveling. Please consider Bond Sales Tumble as Ireland Crisis Spills Over

Corporate bond issuance worldwide is tumbling on concern that Ireland�s debt crisis will spread across Europe as returns on the securities head toward their worst month since the credit market seizure two years ago.

Issuance has slumped 31 percent since Nov. 15, compared with the same period a year earlier, after surging 34 percent in the first half of the month, according to data compiled by Bloomberg.

The Organization for Economic Cooperation and Development cut its global growth forecast for next year, predicting a �soft spot� as stimulus dwindles.

Corporate bonds are poised for their first monthly loss since May, when they fell 0.4 percent, according to the Bank of America Merrill Lynch Global Broad Market Corporate index as of Nov. 26. They�re on pace for the worst monthly returns since October 2008, when the debt lost 4.44 percent as credit markets froze in the wake of Lehman Brothers Holdings Inc.�s bankruptcy.

Elsewhere in credit markets, Hewlett-Packard Co. sold $2 billion of bonds to repay commercial paper. The cost of protecting corporate bonds from default in the U.S. rose to the highest in more than five weeks. Leveraged loan prices fell for a sixth straight day, the longest streak since August. Interest- rate swap spreads narrowed from the widest in more than four months.

Companies are cutting back on commercial paper, short-term borrowings that typically mature in 270 days or less. The seasonally adjusted amount outstanding fell for a fourth straight week to $1.065 trillion in the period ended Nov. 24, the lowest since the week ended Sept. 22, Federal Reserve data show.

Global corporate bond sales declined 64 percent last week to $30.8 billion as European sovereign-debt concerns mounted, Bloomberg data show.

Companies may be postponing bond sales until after Ireland�s situation is resolved, said Greg Tornga, the head of investment-grade fixed income at Los Angeles-based Payden & Rygel, which oversees about $55 billion.

�I don�t think you can find anyone who thinks rates are going to go up so much in 30 days that they can�t wait to issue until Ireland isn�t in the headlines anymore,� Tornga said.

It's Not Just Ireland

Corporate bond bulls like Greg Tornga may even be correct that no one thinks corporate bond rates are going up. If so, everyone should be buying the dip.

Then again, if Tornga really can't find anyone who thinks rates are going to go up much in 30 days, then perhaps everyone is already "all in".

The hook Tornga offers is just what the bulls want to hear - Don't worry; it's all about Ireland; the Irish spillover will soon go away.

I am not a corporate bond investor, but I suggest the time to buy corporates is when yields are high and defaults priced in, not when fools are chomping on the bit in belief lower yields are a "sure-thing".

Record-Low Coupon Punishes Investors

On November 23, Bloomberg reported Microsoft Record-Low Coupon Punishes Investors

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.

Since July, companies from McDonald�s Corp., the world�s largest restaurant chain, to drugmaker Johnson & Johnson, sold debt at record low borrowing costs as investors priced in a slower economic recovery and the Fed held interest rates near zero.

Microsoft, rated Aaa by Moody�s Investors Service and AAA by S&P, obtained the second-lowest borrowing costs for 10-year debt, after Johnson & Johnson and Colgate-Palmolive Co., Bloomberg data show. Investor demand and record-low yields on investment-grade debt helped the world�s largest software maker issue the securities in its second bond offering.

Wal-Mart, the world�s largest retailer, sold $750 million of 0.75 percent bonds on Oct. 18 at the lowest borrowing cost for three-year notes, according to Bank of America Corp., which helped manage the offering. The notes lost 0.41 cent on the dollar to trade at 99.24 cents as of Nov. 18, Trace data show.

JNK - Lehman High Yield Bond Fund



click on chart for sharper image

What's the Risk/Reward Setup?

I use the Lehman JNK index as a proxy for junk bond risk. How much lower can corporate bonds yields go? If not much, then all investors are doing is locking in low yields.

On the other hand, consider the risks. There is a very decent chance that corporate bond yields have bottomed and companies are going to have to offer much higher rates to attract buyers. If so, junk bond funds are going to get hit hard.

Moreover, if corporates get hit hard, it is highly likely equities get hit at least as hard.

Admittedly, that is a decent sized series of ifs.

However, the gain for being an investment-grade bond bull is locking in pathetically low yields just because they are 30 basis points higher than treasuries. Whoop-To-Do.

I fail to see how buying 3-year Walmart bonds at .75% is an attractive offer. I would rather sit in cash, waiting for the right opportunity than to take such rates. Hells bells, a quick check shows 3-year treasury rates are .75%. Is it impossible for treasury rates to dip while corporate bond yields soar? Here�s a hint at the answer - think about what happened in 2008.

Admittedly, the potential gain for junk bonds is higher, but so are the risks, especially after the massive rally in corporate bonds across the board.

On the other hand, if corporate yields soar for any reason, then corporate bond investors are going to get hit with underperformance on assets held to term, and huge realized losses if they sell.

How soon we forget what happens when credit markets turn. Was 2008 that long ago?

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