FEBRUARY 2, 2012
Article from The Wall Street Journal
By RICHARD BARLEY
Europe's disaster movie isn't guaranteed a sad ending. So, investors shouldn't shy away from the region's investment-grade corporate bonds, even though they returned a bumper 2.9% in January. They still look unloved. A 4.2% yield on five-to-seven-year bonds is far above German bund yields and prices in a lot of risk.
Last year, European corporate debt priced in a credit crunch. But the European Central Bank's liquidity injections staved off a systemic crisis. Average European corporate-bond spreads tightened to 2.8 percentage points over government bonds, from 3.3 during January. That still is far above 2011's tightest of 1.6 points.
But the market continues pricing in disaster. The iTraxx Europe index of credit-default swaps on 125 European blue-chip companies, a proxy for corporate-bond spreads, costs €139,000 ($181,842) a year to insure €10 million of debt against default for five years. Assuming a 40% recovery rate, the index is pricing in a five-year default rate of 11.4%, says Tradeweb. Yet the peak default rate since 1970 was 2.4%, says Deutsche Bank. With corporate balance sheets strong and economic data improving, high defaults look unlikely.
Of course, if the euro-zone crisis spins out of control, history may prove of little value. But investors have to put cash to work. Those with absolute yield targets may be tempted to ditch government bonds for higher corporate yields. January's rally could have further to run.
Write to Richard Barley at richard.barley@dowjones.com
Article from The Wall Street Journal