Corporate-bond buyers are increasingly becoming stock pickers.
High-yield debt funds boosted their allocations to equities to 3.2 percent in March from 3.1 percent in December and 2.1 percent at the end of 2012, Morgan Stanley (MS) data show. JPMorgan Chase & Co. (JPM) strategists suggested others do the same, last week advising investors to cut their credit holdings as yields dwindle and switch to equities instead.
While the outlook for American businesses still looks pretty good to investors, they’re growing uneasy about owning bonds that offer some of the lowest yields in history. That angst is only made worse by the reduced liquidity that’s resulted from banks pulling back in debt trading, raising concern that the market will spiral downward when everyone tries to sell at once.
“We see credit as relatively over-owned and valued versus other risk assets,” JPMorgan strategists led by Jan Loeys wrote in a June 13 report. “Investors are beginning to worry about how the eventual exit will fare in a world of reduced market making by banks.”
Equities look more attractive because they haven’t benefited as much as company debt from the easy-money policies of central banks across the globe, according to the analysts.
Corporate bonds may also be hurt more in a sell-off because the biggest dealers are reducing their fixed-income inventories in response to risk-curbing regulations, causing trading volumes to drop.
While the size of the investment-grade company-bond market ballooned 82 percent since the end of 2008, trading volumes only increased 72 percent in the period, according to Bank of America Merrill Lynch and Financial Industry Regulatory Authority data. Since the end of April, an average $13 billion of the debt has been exchanged each day, compared with $13.8 billion in the period last year.
That hasn’t mattered much -- at least not yet -- because central banks have been pumping more and more stimulus into the global economy, pushing investors into riskier assets. That’s made for a one-way market in bonds, with few wanting to sell investment-grade notes that have rallied 61 percent since 2008, Bank of America Merrill Lynch index data show.
So, what happens when sentiment reverses? JPMorgan analysts suggest investors may want to cut their credit positions before finding out.
Junk-bond buyers earned 3.46 percentage points more than benchmark rates to own U.S. speculative-grade securities as of June 10, the lowest since 2007 and 2.41 percentage points lower than the two-decade average. That means fewer potential gains and a smaller cushion against a bear market.
“We are indeed at that point of the cycle where one should not expect that much more spread tightening,” the JPMorgan strategists wrote. “We prefer to take more risk in equities and we now cut the size of our U.S. high-yield spread trade by one-third.”
Managers of junk-bond mutual funds seem to agree. They increased the proportion of assets that fall outside of benchmark indexes to 15 percent of holdings as of March from 14.6 percent in December, according to a June 6 report by Morgan Stanley. They boosted allocations to stocks, securitized debt and loans, the data show.
While almost all U.S. markets may look expensive right now, equities may be a better bet than bonds when central banks start yanking their stimulus.