Investor Safe Haven or Bubble About To Burst?

By: By Charles Riley, CNN staff reporter
By: By Charles Riley, CNN staff reporter

NEW YORK (CNNMoney.com) -- Corporate bonds have been on a tear since the market collapse of 2008, as investors sought refuge from a tumultuous stock market.

The corporate bond market occupies that nice comfortable middle ground between the still volatile stock market and government debt offerings that offer ultra-low yields.

In recent years, investors have withdrawn billions of dollars from equities markets in search of a safe haven, only to find themselves stuck with the declining yields offered by Treasurys. Prices and yields move in opposite direction.

U.S. Treasurys currently have yields ranging from less than half a percent for two-year notes to just over 3% for 30-year longbonds. Compare that with corporate bonds, which offer yields average around 4% for investment grade debt, and 8% for riskier high yield bonds.

"With the improved environment we've seen issuances almost explode," said Kim Rupert, the managing director if fixed income at Action Economics. "Both supply and demand [for corporate bonds] have picked up over the last year."

And boy have they performed.

Both financial grade and high yield bonds have produced gangbuster returns for investors over the last year, according to data from the Financial Industry Regulatory Authority. The total return on investment grade corporate bonds has increased more that 6% in the last year, while riskier and more volatile high yield corporate bonds have shown gains of 15% in total return over the past year.

The index used by Finra to gauge returns in the corporate bond market measures the total amount earned by owning a security, as well as accrued interest, coupons paid out on the bond, and the rise and fall of the bond's price.

Institutional investors led the rush, snapping up the debt offerings of companies deemed too big to fail.

But analysts say corporate bonds are now overbought, and Johnny-come-lately investors looking for a low risk investment with a modest return may have missed the party.

"I'm looking at the market today and I'm saying this is really expensive, and historically that's when you lose money," said William Larkin, fixed income portfolio manager at Cabot Money Management.

The next few months, chock-full of earnings report and economic data, will play a key role, Larkin said.

"The existing trend is we are going to be getting better economic indicators, and as we start to make this turn, we are in front of this huge deluge of information and the market is nervous," he said.

A jump in stock prices and an accompanying rise in interest rates would mean bad news for investors heavily vested in bonds, as those forces could severely cut into or entirely wipe out bond profits.

The risk of rising inflation also makes long-term corporate bonds a risky proposition. The longer a bond's term, the greater the chance that the payout won't keep pace with inflation.

Still, since most corporate bonds come with a fixed rate through maturity, the risk of declining payouts remains less than the type of heavy losses sustained by stock market investors in 2008.

"The reality is retail investors get burned because they are late to the party," said Tom Graff, an analyst at Brown Advisory. "But now they are not chasing returns. They are chasing 'I don't want to lose anything.' So we have to redefine getting burned ... [investors] are going to be disappointed, but not lose much money."

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