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How the Bond Markets React 12.22.04
Flush with Cash
Does the average corporate bondholder understand the result of the large amount of mergers and acquisitions? Do they understand the implications on the credit quality of companies who have so much cash that share buybacks and special dividends? Not likely. The average corporate bond investor - and hopefully they are using a bond fund - has been sort of blind sided by these events. The result of these shareholder friendly actions has been a blow to credit ratings, the driving force behind prices and yield - which work in opposites with prices falling as yields increase.
An equity friendly environment, one where companies turn their backs on creditors has created the smallest spread for bondholders in over a decade. To understand what this means, we should first look at reward and risk. In the world of fixed income, reward comes in the spread. A spread is the distance between the bond offering and comparable Treasuries. When that narrows, creditors or bondholders are paid less for the money they allow companies to borrow. Risk equals leverage which is the ability to pressure a company to pay higher yields because the company needs the money and has nowhere else to turn.
The yield being paid to these bondholders has fallen as the spreads tighten and you would expect these investors to look elsewhere for the yield they seek. So far, that hasn't happened. Is this a sign that they believe the current environment will change soon? Possibly, but until something happens and credit ratings for this group improve, the corporate bond group still has the best reward for risk available.
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