While everyone talks about the "great rotation" from bonds to equities, we've had a different type of rotation taking place within the US fixed income universe - the rotation from treasuries into credit. Here is a simple comparison of total returns between high yield and treasury bonds over the past few months. Corporate credit outperformance has been remarkable.
The result of this "rotation" has been the collapse in corporate spreads, which has been persistent across the credit spectrum. Both investment and non-investment grade bond spreads have not been this tight since the bubble years.
Of course as corporate spreads come in, there is increasingly less cushion to compensate investors for the losses due to rising yields. And yields are likely to rise in 2014. There is no question that at least within corporate credit we are moving into "bubble" territory.
BW: - Spreads on U.S. investment-grade and junk bonds have contracted by almost 700 basis points from a peak of 896 in December 2008, about three months after the collapse of Lehman Brothers Holdings Inc. helped spark a seizure in credit markets, Bank of America Merrill Lynch index data show.
After average annual returns of 10.8 percent since the end of 2008, investors have been left with spreads that are 8 basis points below the average 208 basis points during the 10 years ended 2007, the index data show. That may leave investors with too thin of a cushion against losses should benchmark interest rates climb.
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