Are Bond Prices too High?
The Economist says so:
Buttonwood | Spread too thinly | Economist.com: Many investors in shares argue that the low levels of bond yields make stockmarkets look cheap. To take one example, emerging-market bond spreads (the excess yield over American Treasuries) are close to all-time lows... whereas emerging stockmarkets trade at their usual discount to developed-world shares.... [T]he perceived cheapness of debt is persuading private-equity groups that they can make big profits from buying quoted companies. And the prospect of such bid activity is keeping a floor under share prices....
Pension funds and insurance companies in the developed world have become more cautious... buying bonds in an attempt to match their liabilities. Furthermore, savers are no longer risk-happy Americans but Asian central banks.... [T]he massive growth of credit derivatives... has given investors the ability to sample the debt markets.... Abundant liquidity has persuaded people to accept lower yields as a result.... Companies have been extremely profitable, generating more than enough cash to service their debts; as a result, the default rate has been very low.... The debt markets seem to offer little scope to absorb bad news.... [W]hat will puncture that complacency? The most likely cause would be a big default.... Will the rapid emergence of credit derivatives and the greater role of hedge funds make markets more--or less--stable?...
Another fear is liquidity. Hedge funds have actively provided credit via leveraged loans. There is a risk that, just when borrowers get into difficulty, hedge-fund clients may demand their money back.... Plenty of people believe the financial system is more secure than before.... But the real test of a big recession has yet to be faced...
