Over the last year, investment grade bonds (Baa-/BBB- and better) have been beaten up due to investor uncertainty of getting their money back on their bond purchases. Corporate earnings are falling, dividends are being cut, and some companies are defaulting on their loans. Prices for bonds have adjusted accordingly and corporations have increased their cash reserves to the highest level in 15 years, $675 billion.
Year to date, iShares Investment Grade Corporate Bond (LQD) ETF is down 13.66%. Over the last 5 years it is down 18.62%. With falling bond prices comes higher yields. As of 11/24/08, LQD is yielding 7.52%.
Meanwhile, the iShares U.S. Government Treasuries 7-10 year maturity (IEF) ETF is up 8.14% year to date. Over the past 5 years it is up 10.24%. However, it is only yielding 3.75%. The iShares 1-3 year Treasuries (SHY) is yielding 1.24%.
There are advantages to buying corporate bonds over stocks. First, the corporation is paying you interest to hold their paper while you wait for the bond to appreciate in price. Also, buying corporate bonds also offers more security than buying stocks. When a company files for bankruptcy protection, bondholders will be repaid before stockholders.
The likelihood that Treasuries will continue to outperform corporate bonds is less likely because the Government is selling more bonds to cover new debt, thereby increasing supply. Also foreign governments are less likely to buy U.S. Treasuries because they are using their money to stimulate their own economies.
As soon as investors become more confident that the worst is over, they will start to look for higher returns than the 1% short term Treasuries offer. Look for corporate bonds to benefit from changing investor attitudes.