For the U.S. corporate bond market, 2014 was a pretty lively year. Sales of investment-grade corporate bonds had risen to just shy of $1 trillion by the end of September, putting the market for debt from highly rated companies on target to beat 2013’s record issuance of about $1.1 trillion.1
This surge came as companies took advantage of still-low interest rates to build up cash stockpiles, which allowed them to buy back shares and increase dividends.
Many yield-hunting investors welcomed the boom in issuance because corporate bonds were offering higher yields than Treasuries: The 10-year U.S. Treasury note yielded just 2.5% at the end of the third quarter of 2014, down from 3% at the beginning of the year.
However, the surge in issuance is also raising concerns. One official from the Securities and Exchange Commission warned in October that the $10 trillion U.S. corporate bond market may have entered bubble territory, potentially creating risks for retail investors.2 Given all the corporate debt now circulating in the market, investors need to make sure they’re buying bonds that suit their risk tolerance, says Kathy Jones, Vice President, Fixed Income Strategist at the Schwab Center for Financial Research.
“With more debt on corporate balance sheets, a wobble or two in the economy might make it harder for lower-rated issuers to service their obligations,” she says. “This isn’t a major worry since the economy is improving, but investors should make sure they are being adequately compensated for any risk they’re taking on. Investors who are concerned about credit quality might find highly rated corporate debt more appealing.”
In addition, Kathy believes bonds with intermediate durations—between five and 10 years—offer favorable risk/reward characteristics in the current environment.
1Mike Cherney, “Corporate Bond Sales Coming at Blockbuster Pace,” The Wall Street Journal, 9/30/2014.
2Dave Michaels, “SEC’s Gallagher Sees Bond Bubble Hurting Retail Investors,” Bloomberg, 10/1/2014.