Credit rally: Bubble or not?

February 20, 2012

Corporate bonds are back in vogue this year but how sustainable is it?

Just to highlight how bullish people have become, see following comments from fund managers:

“We do see scope for 2012 to deliver narrower corporate credit spreads and that will be the major positive contributor to fixed income returns this year.” – Chris Iggo, CIO Fixed Income, AXA Investment Managers)

“Corporate bonds should be a major source of performance for the bond component of Carmignac Patrimoine (fund) in 2012.” – French asset manager Carmignac Gestion

Bank of America Merrill Lynch’s performance data as of end-Jan shows high-yield bonds are the second best performing in the bond group with YTD gains of 2.9%, ahead of 10-year Treasuries at 0.8 percent. The best performing is “preferreds”, a sort of hybrid bond/equity instrument which returned 4% this year already.

BofA’s investment team thinks equities will catch up and outpace bonds over the medium term however, because equities have had secular underperformance, pension funds and other clients are structurally under-positioned in stocks, and relative valuations favourequities.

The bank also warns: “Recent inflows into high-yield funds have been bubble like, with record-setting inflows into HY bonds.”

Iggo from AXA is also cautious.

“Credit spreads have narrowed at a pace that probably can’t be sustained. When we look at those assets that suffered most during 2011, we see even stronger returns than for the broad credit markets. Subordinated bank debt has delivered double digit returns so far. European high yield debt is up 8%.”

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