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Bargains in Bonds?

bond.jpgI’ve read several articles recently suggesting that right now bonds are a “once in a century” buy. This is largely because investors no longer trust the ratings of the bond rating companies–Moody’s, Standard and Poor’s, and Fitch–after the big three so badly missed the meltdown of the large financial companies. One bond trader gave me this example: Lehman’s bonds were rated an “A” on the Friday before they filed for bankruptcy on Monday.

If you have to sell a bond in this market, buyers have discounted the price under par to compensate for not being able to trust the ratings. As a result, most high quality bond funds are down around 5% and high yield bond funds are down 20%.

As confidence returns in the rating systems, bond prices will most likely rise. Especially underpriced are high yield (junk) bond funds. The spread between Treasuries and high yield bonds has increased to almost 15%. To put that into perspective, there have only been eight months since 1988 where spreads went over 10%. The historic spread is 5%. The average annual returns on high yield bonds following periods when the spread went over 10% was 17% a year for the next four years. This is probably not the time to sell your high yield bond fund!

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