Is the flight to safety creating bond buyer opportunities?

Fear and panic are equally well at work in both the fixed income markets and the equity markets. According to fund-tracker AMG Data, investors pulled more than $1 billion out of junk-bond funds since September, worried that default rates could spike from their current low of 3% for the first nine months of the year. But what about the nearly $6 billion they have pulled from investment grade Corporate bond funds? It looks like a lot of high-quality non-financial corporate debt is being thrown out with the bathwater. On average, investment grade debt is selling for 87 cents on the dollar to yield 8.5% vs 69 cents for potentially toxic junk yielding 17%, according to Merrill Lynch.

Overall, the $2.5 trillion market for investment grade Corporates has fallen 11% since the start of September 2008 and 11.5% since the start of the year—as compared to a loss of 3.3% in 1994, its worst year ever. Junk has fallen 17% since September and 19% since the start of the year. Its worse annual loss ever was 5% in 2000, when tech stocks cratered. Meanwhile the
spread between investment grade Corporates and Treasuries is at an unprecedented 5.35 percentage points while the junk spread versus Treasuries is a huge 14 percentage points. The flight-to-safety has made Treasuries the only positive fixed-income performer year-to-date.

The Corporate bond market appears to be forecasting a recession as bad as the Great Depression. And while we expect non-financial sectors to feel the effects of recession, we also see the Fed and the Treasury working to relieve the financial crisis and limit the degree of slow down. High quality Corporates with stable underlying cash flow streams, low debt levels and operating in low-default defensive sectors such as consumer staples, utilities and health care could prove to be attractive buying opportunities for long-term investors.