There is little sign of a bubble in the corporate bond market, with none of the irrationality that m...
There is little sign of a bubble in the corporate bond market, with none of the irrationality that marked the technology, media and telecom boom of the late 1990s, according to Aegon bond fund manager Stephen Snowden.
'Looking in the financial pages, there are loads of people recommending corporate bond funds. This is a classic sell signal for the contrarian investor. I can't blame anybody for thinking that with the way bonds have performed against equities, it is finally time to sell out of bonds and get back into stocks,' he said.
But while the seasonal themes of recent years have rarely created value for investors, the corporate bond market is not attracting feverish speculation and an epidemic desire to get rich quick like the technology sector at its peak, he said.
'When you are in the middle of a bubble, valuations become insane. At the top of the Japanese equity and property market bubbles, it was reckoned that the land underneath the Imperial Palace in Tokyo, which covers less than a square mile, was worth more than California, which covers more than 156,000 square miles,' he said.
In contrast, BBB rated bonds in 1999 paid four times as much additional yield as was required to cover investors for default risk, compared to three times cover at current prices.
'So corporate bonds are more expensive than they have been in the past. However, in 1997, you only got paid two times cover, so you could say corporate bonds are just trading in the middle of their historical range,' Snowden said.
Bubbles also generally see the emergence of mad theories to justify unsustainable prices, but this has not happened during the bond rally, he said.
'Pension funds and life insurance companies are using bonds more, but the rationale for investment is still exactly the same as it always has been. Whether you look at valuations, the level of speculation, or the emergence of new paradigms, you cannot say we are looking at a corporate bond bubble,' he said.
The sell signals that proliferated during the equity boom are not yet evident in the bond market, Snowden said.
'The time to sell your corporate bonds is whenever the extra yield that you receive over government bonds no longer compensates you for the default risk you are taking. When you start reading articles in the press theorising that default premiums are based on historical analysis and going forward companies are not going to go bust as often, sell your bonds.'
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