Some economists say a rebound could be in the offing. In Congressional testimony last week, Ben S. Bernanke, the Federal Reserve chairman, said that there was “a reasonable prospect” that the recession might end this year — echoing recent surveys of business economists. But Mr. Bernanke said this would be possible only if recent actions by the White House, Congress and the Fed quickly stabilized the nation’s shaky financial system.
That’s a huge “if.” And investors may not feel moved to make a bet on stocks based on those odds.
Yet even the most skeptical investor can benefit from a potential recovery without committing to a large equity stake, several strategists say.
The idea is simple. Although in general it is smart to rebalance by moving money from the best-performing assets to the underachievers, one need not dive into stocks. Rather than selling Treasury holdings — the only asset that’s done well lately — to buy more shares of beaten-down stock, consider shifting some of that money into beaten-down investment-grade corporate bonds instead.
“Think of it as your Plan B,” said Ernest M. Ankrim, senior markets adviser for Russell Investments. “It’s a subdued asset relative to stocks but which has the possibility of giving me decent returns if the economy improves.”
To be sure, corporate bonds could still lose money, especially if an economic recovery doesn’t materialize quickly. This is particularly true among so-called high-yield or junk bonds, non-investment-grade debt of companies with worrisome balance sheets. Last year, the average high-yield bond fund lost a whopping 26 percent, according to the research firm Morningstar.
That’s why some strategists emphasize higher-quality debt. Even so, the average intermediate-term investment grade bond fund fell by nearly 5 percent in 2008, and many portfolios lost more than 15 percent. Still, in relative terms, that was a far cry from the 37 percent loss suffered by stocks in the Standard & Poor’s 500-stock index, Mr. Ankrim said.
This strategy is timely, he added, because falling stock prices and rising market volatility continue to deter investors from rebalancing portfolios by shifting more heavily into equities.
“Rebalancing may be too much to ask of some investors who’ve lost more than 50 percent,” he said.
Moreover, there are some unusually good values among investment-grade corporate bonds — assuming, of course, that the economy is on track for a recovery sometime soon.
As corporate bond prices have sunk, their yields have soared. How much? Since 1989, the difference in yields between 10-year Treasury securities and 10-year corporate bonds with a Baa-rating — the lowest rung among the so-called investment-grade bonds — has averaged about 1.9 percentage points, Mr. Ankrim noted. But thanks to the heightened fear in the financial markets, this yield spread jumped to as 7.4 percentage points late last year. So far this year, it remains well above six points.
With 10-year Treasury notes yielding 3.0 percent, this means you can find some high-quality corporate bonds yielding 9 percent, around the historical return of blue-chip stocks.
Now, consider the possibility that the recession ends fairly soon. In that case, the spread between Treasury and corporate bond yields would likely narrow — and corporate bond prices would generally rise.
The combination of price appreciation and healthy yields would lead to solid total returns for corporate bond investors, said Robert D. Arnott, chairman of the investment management firm Research Affiliates.
Of course, there’s also a substantial possibility that the economy will look bleaker in the months ahead.
“Suppose the economy turns out to be worse than the Great Depression,” Mr. Arnott said. In that case, he said, “stocks fall in half again, but the bonds will hold up better.”
Why? As long as the bond issuer stays in business, you’re likely to get generous payouts regardless of economic conditions. And should the company go under, you’ll still recoup more of your assets than equity investors because bondholders enjoy preferential status under bankruptcy laws.
This is only a tactical strategy based on current market conditions. Once the economy starts showing signs of real improvement — and as corporate bond spreads narrow — investors must reassess their appetite for risk and think about moving this ersatz allocation back into equities, Mr. Ankrim and Mr. Arnott said.
INVESTORS should also consider the risk in keeping too much of this money in corporate bonds for too long.
Robert L. Rodriguez, chief executive of First Pacific Advisors and co-manager of the FPA New Income fund, warns that with all the monetary and fiscal stimulus being deployed, inflation is likely to make a significant comeback sometime within the next three to five years.
And though many stock investors fear inflation, bondholders traditionally hate it even more. That’s because rising prices can eat away at a greater portion of the modest returns that bonds typically deliver.
So if investors are planning to rebalance into corporate bonds instead of stock, they should select a fixed-income manager who favors shorter-term securities.
“Or, if you buy the bonds directly, keep your maturities no longer than about five years,” Mr. Rodriguez said.
“If I’m correct, and inflation is coming back,” he said, “then you want to be defensive.”
Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.
