Strategists from Bank of America Corp. to Wells Fargo & Co. predict dollar-denominated corporate bonds will outperform stocks this month if political gridlock persists with the government partially shut down this week.
Company debt in the U.S. has gained 1% since Sept. 17, the day before the Federal Reserve surprised investors with its decision to maintain unprecedented economic stimulus, compared with a 0.5% decline on the Standard & Poor's 500 Index. In August 2011, the last time legislators approached a deadline to raise the debt limit, investment grade bonds returned 0.13% while U.S. stocks declined 5.4%.
“Investment-grade credit can produce attractive risk- adjusted returns relative to equities or other risk assets,” Edward Marrinan, a credit strategist at Royal Bank of Scotland Group Plc's securities unit in Stamford, Connecticut, said in a telephone interview. “If there's an asset class that's more vulnerable amid a protracted government shutdown and a contentious debt-ceiling debate, it's equities.”
Even with corporate bonds trading at yields within a percentage point of all-time lows, they're set to perform better than stocks this month, according to Bank of America's Michael Contopoulos, as any weakening of the economy resulting from the shutdown will likely prolong the Fed's $85 billion of monthly purchases of mortgage bonds and Treasuries.
“If negotiations in Washington continue to be unfruitful, stocks will be more vulnerable than credit,” Mr. Contopoulos, a high-yield credit strategist in New York, wrote in a Sept. 26 report. “The focus away from increasing rates to the rising probability of a government shutdown implies that equities are likely to underperform credit over the next month.”
Congress’s failure to pass a budget by Sept. 30 partially closed the government yesterday for the first time in 17 years, costing the U.S. at least $300 million a day and setting the stage for a debate on raising the U.S. debt ceiling.
The shutdown temporarily put as many as 800,000 federal employees out of work, halting some government services. Gridlock over the budget or a failure to raise the debt limit “could have very serious consequences” for the economy and policy makers will have to take that into account, Fed Chairman Ben S. Bernanke said Sept. 18 at a news conference in Washington after the central bank’s decision was released.
Investors funneled $2.9 billion into U.S. high-yield bond funds last week, the second-highest inflow this year, and $1.7 billion into investment-grade funds, the most in 17 weeks, Bank of America data show. Yields on dollar-denominated corporate bonds have narrowed 9 basis points since the end of August, to 4.12% from this year’s high of 4.37% on Sept. 5, Bank of America Merrill Lynch index data show.
The bond gains follow a 2.3% loss in the first six months of the year on the Bank of America Merrill Lynch U.S Corporate & High Yield Index, when investors demonstrated mounting concern that the U.S. economy had improved enough for the Fed to start reducing its bond purchases. The S&P 500 posted a total return of 13.8 percent in the period, its biggest gain since 1998.
“We’re going to see an increase in volatility surrounding this debt ceiling debate” in the equity markets, said Scott Wren, a senior equity strategist at Wells Fargo Advisors LLC, the subsidiary of Wells Fargo that oversees about $1.3 trillion of assets. If stocks sell off, he said, “you’d see bonds rally from here.”