Bonds: What's Behind the Bounce in Corporates?

Warren Buffett's investment in Tiffany and other factors are helping lift prices for corporate bonds

By David Bogoslaw

Even as equity indexes retested their November 2008 lows on Feb. 17, the bond market was telling a different story. Spreads between the composite yield on investment-grade corporate bonds and U.S. Treasury bonds of comparable maturity narrowed to their tightest levels since the beginning of the new year, indicating that investors have regained some appetite for corporate bonds even as equities resumed their slide. That's a far cry from the oft-heard remark last fall that if stocks were priced for an impending recession, corporate bonds were being priced for a depression.

Corporate bond yields, or the interest rate that bondholders earn, have dropped dramatically over the past three months, which means corporate bond prices have been rising. After reaching nearly 600 basis points in early December, the spread over Treasuries had narrowed to 470 basis points as of Feb. 17.

One reason for what Tom Murphy, manager of the Diversified Bond Fund (RDBIX) at RiverSource Investments (AMP) in Minneapolis, calls a "decoupling of equity and bond markets" recently is the absence of the forced selling by hedge and mutual funds that made both stock and debt investors skittish at the end of 2008. "Now people are doing a more rational analysis of the risk/reward [comparison] and can still get comfortable with that even as the equity market trades down to its lows," he says. "We need to continue to make progress. I'm not naive enough to think that if equities continue to test the lows, that the corporate debt market" can stay immune to stocks' downdraft.

Buffett Bullish on Tiffany

Billionaire investor Warren Buffett's investment in Tiffany (TIF) debt has also helped stoke more confidence in corporate bonds. On Feb. 12, subsidiaries of Buffett's company, Berkshire Hathaway (BRKA) bought $250 million of Tiffany's 10.00% Series A-2009 and Series B-2009 Senior Notes due in February of 2017 and 2019, respectively.

Murphy sees the investment as consistent with Buffett's purchasing preferred shares of companies after the Lehman Bros. collapse last September in order to have stakes higher up in the capital structure. "It's a high-profile example of people [looking at] the debt vs. equity trade-off at relative valuations and deciding they'd rather own the debt," he says.

Companies are returning to the credit markets— if not in a torrent, at least in a steady stream. On Feb. 17, DuPont (DD) sold $900 million of debt in a two-part sale, comprised of $400 million of six-year notes priced at a 4.75% yield and $500 million of 10-year notes priced at a yield of 5.75%. Both tranches were done at yields 313 basis points over comparable Treasuries, according to IFR, a Thomson Reuters service. The same day, Honeywell (HON) sold $600 million of 3.875% Senior Notes due 2014 and $900 million of 5.0% Senior Notes due 2019. Roche Holdings' (ROG.VX) offering on Feb. 18 was the biggest by far: a six-part sale in the private placement market worth a total of $16 billion, of which $13 billion has a maturity of two years or more.