Corporate Bonds and Munis May Be Way to Profit from Economic Meltdown

As markets continue to gyrate, corporate and muni bonds may offer steady and in some cases extraordinary returns. Depending on the risk you are willing to take some corporate bonds yield 18%+. Munis can offer 6.5% tax free.

As markets continue to gyrate, corporate and muni bonds may offer steady and in some cases extraordinary returns.  Depending on the risk you are willing to take some  corporate bonds yield 18%+.  Munis can offer 6.5% tax free. 

From the WSJ:

"For example, the yields on corporate bonds that ratings agencies consider below-investment-grade -- so-called junk bonds -- are 16 percentage points higher, on average, than yields on U.S. government debt of similar duration, according to Merrill Lynch data. A 10-year junk bond might yield 18%, compared with roughly 2% for the 10-year Treasury note."

That is an astounding gap; two years ago, junk bonds yielded just two percentage points more than Treasurys. This "spread" is not much lower than its record high of about 22 percentage points, set in November. Many analysts say this represents a much direr outlook for the economy and corporate bankruptcies than even the stock market does.

"Yield levels and the expected default rates they imply are way out of line with everything but a nuclear bomb," says Vinny Catalano, chief investment strategist at Blue Marble Research.

Munis also offer great returns at the moment.  Munis, which have histrocially been safe investments historically yield less than treasuries.  Today, they are providing yields that are two percentage points higher than the comparable T-bill.

Safer than Equity

Another advantage of holding bonds is that bondholders have more rights in the case of bankruptcy of financial distress.  As many of the banks have shown, bondholders are often preserved even when equity-holders are wiped out.  When you buy stock, you are the last in line to be paid anything that remains if the company goes under.  Bondholders have much higher standing.

Buyer Beware

There is a reason of course why these bonds yield so much.  Investors are worried that a slowing economy will result in a wave of corporate and municipal bankruptcies.  If you decide to wade into the bond market, make sure you do some homework.   If buying a corporate bond, be sure to check the company's balance sheet to be sure it is strong and can make any future interest payments.  If buying a muni, check out the type of muni bond.  General Obligagtion bonds are supported by the taxpayers of the issuing municipality.  If a municipality gets into trouble, these obligations are generally very high on the list of budget priorities.  Municipalities rarely default on general obligation bonds because they can cut budgets, stall projects, raise taxes, etc. as ways to make sure the debt payment is made.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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Comments

  • TPowers

    January 22, 2009

    Much more attractive that equities here.

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