Company debt from the U.S. to Europe to Asia returned 1.8% last month on average, erasing a 0.65% loss in June, and the most since a 2.14% gain in August 2010.
Investors seeking protection from the sovereign debt crises roiling Europe and the U.S. are targeting corporate bonds, driving returns last month to the highest levels in almost a year.
Company debt from the U.S. to Europe to Asia returned 1.8 percent last month on average, erasing a 0.65 percent loss in June, and the most since a 2.14 percent gain in August 2010, according to Bank of America Merrill Lynch index data. In the U.S., investment-grade bonds led by retailer Wal-Mart Stores Inc. and computer software maker Oracle Corp. outperformed stocks by 4.44 percentage points, also the most since August.
“Corporations are the strongest balance sheets out there,” Mark Kiesel, the global head for company bonds at Newport Beach, California-based Pacific Investment Management Co., which runs the world's biggest fixed-income fund, said in a telephone interview. “Government balance sheets are deteriorating at the same time that the multinational balance sheets have shown their strength.”
Investors are embracing corporate debentures as European leaders try to keep the bailouts of Greece, Ireland and Portugal from spreading to Spain and Italy, and ratings firms threaten to cut America's AAA grade. Even though there are signs of a slowing economy, companies have boosted their appeal to bond buyers by stockpiling cash and exceeding earnings forecasts.
‘Weather the Storm'
Companies had a record $1.91 trillion in cash and other liquid assets at the end of the first quarter, up from $1.39 trillion two years earlier, according to Federal Reserve data issued in June. Ratings upgrades at Standard & Poor's exceed downgrades this quarter by a ratio of 2.12-to-1, the fastest pace in at least a decade, according to data compiled by Bloomberg.
“The market's currently saying even if something does happen, if it's not a calamity, companies can probably weather the storm better than some of the governments out there,” said Eric Takaha, a director of corporate and high-yield for Franklin Templeton's fixed-income group in San Mateo, California.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 0.6 basis points to a mid-price of 95.6 basis points as of 11:18 a.m. in New York, according to Markit Group Ltd.
The index, which earlier today fell as low as 93.4 following an agreement reached over the weekend to raise the nation's debt ceiling, pared the decline on a report showing U.S. manufacturing expanded in July at the slowest pace in two years.
Spreads Widen
The benchmark credit index typically falls as investor confidence improves and rises as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meets its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Relative yields on company bonds worldwide widened 2 basis points last week to 171 basis points, or 1.71 percentage points, according to Bank of America Merrill Lynch's Global Broad Market Corporate Index. The index rose from 163 on June 30. Average yields fell to 3.649 percent from 3.772 percent on July 22 and 3.897 percent at the end of June. The worldwide index has returned 4.27 percent this year.
High Yield
Spreads on the Bank of America Merrill Lynch Global High Yield index widened 19 basis points for the week to 567 basis points, expanding from 548 on June 30 and 555 at year-end. Yields rose to 7.666 percent from 7.635 percent at the end of the previous week. The index of bonds, rated lower than Baa3 by Moody's Investors Service and below BBB- at S&P, has returned 5.9 percent for 2011.
The Barclays Capital Global Aggregate Corporate Index returned 2.16 percent last month, bringing the gain for the year to 7.33 percent.
U.S. gross domestic product climbed at a 1.3 percent annual rate in the second quarter, less than the 1.8 percent forecast of economists surveyed by Bloomberg.
President Obama said late yesterday that leaders of both parties in the U.S. House and Senate had approved the deal to raise the nation's $14.3 trillion debt ceiling and cut the federal deficit. The accord would cut $917 billion in spending over a decade, raise the debt limit initially by $900 billion and charge a special committee with finding another $1.5 trillion in deficit savings. The deadline for approval is tomorrow.
Downgrade Likely
S&P, which has given the U.S. a top ranking since 1941, reiterated on July 21 that the chance of a downgrade is 50 percent in the next three months and it may cut the nation as soon as this month. Moody's put its equivalent Aaa ranking on review on July 13.
Without a deal on the debt ceiling, a one-step cut to the U.S. rating is likely, which would spark a sell-off in longer- dated Treasuries, said Edward Marrinan, the head of macro credit strategy at Royal Bank of Scotland in Stamford, Connecticut.
“High-quality corporate credit would see an increased bid as investors fled to the relative safety of cash-rich companies,” Marrinan said. “Credit fundamentals are outstanding, which investors recognize and are looking to take advantage of.”
U.S. investment-grade bonds returned 2.3 percent in July, the most in two years, Bank of America Merrill Lynch index data show, even as the S&P 500 stock index declined 2.15 percent.
‘Pretty Good' Fundamentals
“Corporate fundamentals are still pretty good, valuations in corporations are still attractive,” said Takaha at Franklin Templeton.
About 78 percent of S&P 500 companies that have reported earnings this quarter have beat analysts' expectations, Bloomberg data show.
“People feel confident that corporate credit risk is at a good spot,” Ashish Shah, head of global credit investments at AllianceBernstein LP in New York, said in a telephone interview. “Stocks are about the growth of those earnings. Corporate credit risk is about making sure those earnings aren't shrinking.”
In the U.S., the safest corporate bonds, with AAA ratings matching the government's, gained 2.28 percent in July, beating the riskiest bonds, which returned 0.51 percent, Bank of America data show. Bonds of Bentonville, Arkansas-based Wal-Mart returned 4.16 percent last month, while those of Oracle in Redwood City, California, gained 3.64 percent.
Reducing Exposure
In Europe, corporate bonds returned 1.15 percent, the best performance since last August. Globally, high-yield returns lagged behind, gaining 0.94 percent.
Pimco is cutting exposure to debt from riskier companies and bonds lower in the capital structure, Kiesel said.
“For the more levered companies, it will be increasingly challenging for them to raise money if we don't get through this period of uncertainty,” Kiesel said.
The highest-quality corporate bonds outperformed as investors sought a “defensive play,” said Mikhail Foux, a credit strategist at New York-based Citigroup Inc.
“It wasn't clear for some time until people started actually getting more focused on the idea of a potential downgrade of the U.S. and looking for potential defensive assets,” Foux said. “High-quality and non-financials are among those assets.”
--Bloomberg News--
