May 3 (Bloomberg) -- Fidelity International and Putnam Investments say the best is over for below-investment-grade bonds after the longest rally since 1998.

From Ford Motor Co. in Dearborn, Michigan, to Royal Ahold NV in Amsterdam, junk bonds have gained in each of the last 10 months, returning an average of 12.2 percent since July, according to indexes compiled by Merrill Lynch & Co. Government bonds returned 2.01 percent in the same period, Merrill says.

Investors are charging less than half the yield premium to buy junk bonds compared with 1998, when Russia's default and Long-Term Capital Management LP's collapse caused prices to decline. Now investors are concerned the slump in U.S. subprime mortgages may signal the best of the rally is over.

``The laws of gravity are being ignored and there will undoubtedly be some correction soon,'' said Anton Simon, who invests more than $1 billion as head of European high-yield debt at Putnam Investments in London. Putnam is being ``cautious,'' he said, declining to give details. The Putnam World Trust II Global High Yield Bond Fund Simon manages owned Ford 7.875 percent bonds due in 2010 and NRG Energy Inc. 7.375 percent debt maturing in 2016 as of December, regulatory filings show.

Rising corporate profits and the fewest defaults in a decade lured buyers to bonds rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's. The yield premium above government debt that investors accept to buy the bonds has fallen to 2.64 percentage points on average, down from 3.39 percentage points in July, Merrill data show.

`It Will Crack'

``It will crack at some point,'' said Ian Spreadbury, who manages the equivalent of about $2.3 billion of high-yield bonds at Fidelity in London. ``You don't know when and you'll never see it coming.''

Spreadbury, whose holdings in the Fidelity European High Yield Fund he runs included El Paso Corp. 7.125 percent securities due in 2009 and Fiat Finance & Trade 6.625 percent notes due in 2013, said he was seeking to limit the risk of his holdings. He declined to provide specifics.

U.S. junk bonds dropped 5 percent in August 1998 as Russia's $40 billion default triggered losses across Wall Street that culminated with the collapse of Greenwich, Connecticut-based hedge fund LTCM.

Many investors are betting against a decline. Morgan Stanley's Global Risk Demand Index is close to an all-time high, showing investors are about as unconcerned about the dangers of a global market rout as they were before the February slump in the U.S. market for subprime mortgages to people with poor credit histories. The Standard & Poor's 500 Index is at a six-year high.

`Dangerous to Jump'

``The subprime crisis is perhaps the first material warning sign,'' said Craig Abouchar, who manages the equivalent of about $640 million of bonds and loans as head of European high-yield debt at Insight Investment Management in London. ``The market is very stretched and people are asking what the catalyst for a crash might be.''

Investor demand spurred a 23 percent increase in sales of junk bonds to a record $75 billion through April, compared with the same period last year, according to data compiled by Bloomberg.

Phoenix-based Freeport-McMoRan Copper & Gold Inc., the world's largest publicly traded copper company, sold $6 billion of debt in March, the biggest high-yield offering since the 1980s. Its 8.375 percent notes due in 2017 have risen to 109.375 cents on the dollar from 100, reducing the yield to 6.81 percent, according to Trace, the bond-price reporting system of the NASD.

``People haven't been paid for being bearish,'' said Paul Watters, director of loan and recovery ratings at S&P in London. He said some investors may be reluctant to sell because they would underperform rival fund managers. ``It's dangerous to jump off the escalator before it reaches the end.''

Fewer Defaults

The corporate debt default rate, now 1.4 percent, is the lowest since 1997, according to Moody's. Companies in the Standard & Poor's 500 Index have reported an average 12.8 percent rise in first-quarter profit from a year earlier, according to data compiled by Bank of America Corp. In Europe, 13 of the 19 Dow Jones Stoxx 50 Index companies that reported first-quarter earnings beat forecasts, Bloomberg data show.

Fidelity's Spreadbury said his concerns are eased by gains in stocks, low financial market volatility and a growing global economy.

``Given the benign default environment, investors are feeling good and have a lot of money to invest,'' said Leland Hart, managing director of leveraged capital markets at Lehman Brothers Holdings Inc. in London.

Stop & Shop

Ford's $4.8 billion of 7.45 percent notes due in 2031 rose 9.4 cents to 79.4 cents on the dollar since July 1. The yield on the bonds of the second-biggest U.S. automaker dropped to 9.66 percent from 10.99 percent, Bloomberg data show.

Bonds sold by Royal Ahold, the owner of Stop & Shop supermarkets, also gained. Its 407 million euros ($554 million) of 5.875 percent notes due in 2012 increased about 2 cents to 104.6 cents on the euro since July, according to Bloomberg data. The yield has fallen to 4.79 percent from 5.3 percent, Bloomberg data show.

``At the end of the day, fundamentals rule,'' said Abouchar at Insight Investments. ``Right now, margins are good, profits are high. The danger may come from a downturn in the macro environment and the U.S. is getting close to that now.''

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

Last Updated: May 2, 2007 19:33 EDT