This year's $500 billion borrowing binge by U.S. corporations could jeopardize bonds' reputation as a safe haven for investors. Rarely have investors accepted such paltry interest payments for corporate bonds, which are far riskier than Treasuries.
The bond market hasn't experienced a sharp sell-off in five years. Lisa Coleman, head of global credit strategies for Schroders Investment Management, says bond prices could weaken as soon as this month, ahead of a flurry of summer issues; a painful correction could come next year.
Lower prices can cause losses on existing bonds if you sell before maturity. "It is going to be really nasty when it starts to unwind," Coleman says. Investors, she says, should avoid adding to holdings of the riskiest securities, known as high-yield or junk bonds. She has shifted some of her firm's $1.5 billion U.S. high-yield portfolio into cash equivalents.
Hedge funds and other risk-seeking investors have poured into bonds. Until recently, this demand drove interest rates — and corporate borrowing costs — down. Companies have increasingly used the proceeds for acquisitions and stock repurchases. Bond issuance could top $1 trillion this year for only the second time ever.
For now, the market appears healthy, with less than 1 percent of corporate issuers in default. But the long-term average default rate is 5 percent. Bonds rated CCC to C — one notch above the lowest credit standing — have never been more popular, according to credit research firm Fitch Ratings, accounting for $1 in $5 of high-yield bonds issued last year, versus $1 in $20 in 1999.
