Why Bonds Are Cool Again, Even For Stock Investors

Big fund managers are rushing to bonds in the biggest one-month rotation ever as investors accelerate their flight from a plunging equities market. Investors' move to bonds is motivated by the search for profit as much as safety. Rising interest rates have sent the price of many U.S. corporate bonds tumbling below their face values, attracting bargain hunters, The Wall Street Journal reports. The financial crisis of 2008 was the last time that large numbers of corporate bonds sunk so low.

Significance For Investors

From October through mid-November, roughly 70% of investment grade U.S. corporate bonds traded below or at their face value (also called par value or principal value), based on analysis by MarketAxess, the provider of a leading electronic trading platform for fixed income securities, per the Journal. Barring adverse developments that impair the issuer's ability to meet its obligations, such as bankruptcy, buying a bond below face value boosts the likelihood of making a profit if held to maturity.

If the issuer redeems (or calls) the bond earlier than the stated maturity date, a profit can be realized even earlier. Also, should bond prices recover, the investor will have another opportunity to sell at a profit. Meanwhile, the investor also is earning interest on the bond during the holding period.

Safety also is a major driver of the move to these and other fixed-income securities. "Investors are close to extreme bearishness," says Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, as quoted in its latest Global Fund Manager Survey. In particular, 53% of respondents expect global economic growth to weaken in the next 12 months, their most pessimistic outlook since October 2008 at the height of the financial crisis. Also, 37% are concerned about the negative impacts of trade wars. As a result, these fund managers have increased their allocation to bonds by 23 percentage points, "the biggest ever one-month rotation into the asset class," the report indicates. Survey participants included 243 fund managers with a collective $694 billion under management.

Looking Ahead

To be sure, moving into bonds is no guarantee of safety or profits as bond prices already have suffered this year.

A key risk going forward for bond investors is that highly leveraged companies will find it difficult to meet their obligations as interest rates rise, and as a slowing economy crimps revenue and profit growth. New issues of corporate debt are having to offer increasingly higher interest rates to entice investors, with high-yield bond spreads experiencing an especially large jump, the Financial Times reports.

In fact, nervous investors are shunning high yield bonds, known as junk, putting December on track to be the first month in more than ten years in which not a single new high yield issue came to market in the U.S., per another FT story. That report observes that "the high level of corporate leverage has raised widespread concern among regulators, analysts and investors."

Finally, buying bonds that are trading at a discount to face value may be questionable as a strategy for quick profits right now. With the reversal of quantitative easing (QE) by the Federal Reserve and other central banks around the world, the immediate trend in interest rates may continue to be up, further depressing bond prices.