Thursday, August 27, 2009

Corporate Bonds: Asset Class Review

Recent asset class reviews have focused on grains, industrial metals, Treasury debt, and crude oil, gold, and the U.S. dollar. In this look, we will examine U.S. corporate bonds: investment grade (LQD; top chart) and high yield (JNK; bottom chart).

Note that bond prices plunged during the late 2008 crisis, as investors fled riskier debt and sought safe haven in Treasury instruments. Interestingly, one tell for the market bottom in March was the fact that we made new lows in high yield bond prices, but not investment grade.

Since that time, investment grade bonds have steadily moved higher, retracing much of their decline from 2008. High yield bonds have retraced only a portion of their total declines, but note that their percentage gain from the March lows has been higher than that for investment grade bonds. This, like the rally in emerging market equities, is an example of how we have seen riskier assets lead the way during the 2009 recovery.

Most recently, the new highs in LQD have not been confirmed by JNK. That is just another one of the non-confirmations on my radar, as riskier assets have recently underperformed safer ones. I am watching these intermarket themes closely to see if the dynamics of the market recovery are changing or if this is simply an August pause that refreshes the risk rally.

1 comment:

Matthew C. said...

Dr. Steenbarger,

One thing I haven't heard you discuss yet re: the present rally is the question of valuation.

I have grave concerns that the valuation levels in equity markets during the financial crisis have never approached past bear market lows (8-10). Today the S&P 500 is trading at a trailing P/E ratio around 140. Even when the "kitchen sink" quarter of 4Q08 rolls off the metric in a few more months, the S&P trailing P/E ratio will be in the 40ish range.

Of course, bear-market bottom valuations for the S&P would put the index in the 250-350 range or, with significant earnings growth (which seems very unlikely to me based on the macro factors) would still put it well below 500. Are stocks now at a "permanently high plateau" where P/E ratio will never be allowed to dip below 20 by the Treasury and Fed?