Corp bond spreads at Great Depression levels

Corporate bond spreads have widened out to levels not seen since the Great Depression following indiscriminate sell-offs in the markets.

Spreads have blown out rapidly over the last three years, with some A to AAA bond spreads reaching their widest point ever.

Those on the Merrill Lynch Global Broad Market Corporate index, which includes 8,000 issues from the US, UK and Europe, is now 485 basis points above government bonds. Three years ago the spread on the same index was 71 basis points.

Schroders' head of UK and European credit strategies Adam Cordery said credit markets are pricing in a far worse scenario than is likely to happen, despite the possibility of a global recession.

"In all likelihood there will be a bad recession everywhere next year. There will be defaults and companies being downgraded, so one reason spreads are going up is to reflect this possibility.

"Another reason is that some people went very overweight credit when spreads were the lowest they had ever been in June 2007. Now investors are all heading for the door at the same time.

"People have talked themselves into misery, but it probably will not be as bad as the 1930s. If it is, then it is already priced in," he said.

Cordery's main reason for his optimism the downturn will not reach Depression proportions is the speed of intervention by the authorities.

He said in the 1930s, the US government dragged its feet and failed to spend any public money to alleviate the crisis, while this time governments around the world have taken well-publicised steps to shore up their economies.

He believes now is the perfect time for investors to buy selected corporate bonds because this sort of value may never be seen again.

Alex Ralph, co-manager of the Artemis Strategic Bond fund, said although corporate bonds are looking excellent value, there is still short-term volatility in the asset class.

"Over the medium to long term it is a very good time to buy, but there is volatility in the short term. However, even if you are pessimistic, you are still being compensated for that at these valuations," she said.

Ralph explained the main drivers behind widening spreads have been hedge fund redemptions, banks de-risking and removing credit from their balance sheets, and the resulting excessive supply of bonds.

Paola Binns, manager of Royal London Asset Management's Ethical Bond fund, said credit markets are pricing in a scenario in which around one-third of issuers would default. She believes investors are selling into fear over irrational pricing.

"In the cold light of day, yes, it is a good time to be buying, but I do not know how far down the road we are in terms of hedge funds unwinding. They will not bounce back tomorrow. It is going to be a slow recovery, but these bonds do look excellent value," she said.

Categories: Investment

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