New Sovereigns: Corporate Bonds With Lower Default Risk than U.S. Treasuries

The rapidly expanding ETF universe now includes several options for income investors.

– Ben Shepherd, Global ETF Profits

It finally happened. With the political clowns in Washington continuing to fiddle while Rome burns, the five-year credit default swap (CDS) spread on U.S. Treasuries is now higher than it was at the peak of the European debt crisis in February 2010. Back on February 8, 2010, the spread peaked at 59.70 basis points (bps) and today it hit 61.85 bps:

Source: Bloomberg

A basis point equals 1/100^th of a percentage point, so 61.85 bps equals 0.6185 percent. The spread on a CDS is the percentage of a bond’s principal value that a CDS buyer must pay to a CDS seller to insure against the bond’s default. For example, the current 61.85 bps spread on  five-year U.S. Treasuries requires the buyer of the CDS to pay the seller $61,850 per year to insure $10 million worth of 5-Year U.S. Treasury bonds.

Political Chaos in Washington D.C.

With time running out before the August 2^nd deadline to raise the country’s $14.3 trillion debt ceiling, the Democrats and Republicans in Washington continue to prove how dysfunctional our national governance has become. Instead of working together on a bi-partisan debt-reduction plan, each party is wasting time devising its own plan, which will pass its controlled wing of Congress, and then quixotically hopes it will be able to cram its partisan plan through the other wing of Congress. Clueless!

Making matters worse, the respective plans of Republican House Speaker John Boehner and Democratic Senate Majority Leader Harry Reid have both been shown by the Congressional Budget Office to cut the budget deficit by less than promised. Neither plan cuts anywhere near the $4 trillion that Standard and Poor’s has said is necessary to avoid a U.S. sovereign credit rating downgrade.

What a mess.

A majority of economists surveyed by Reuters now believe that a downgrade of U.S. debt is likely. A credit downgrade will raise the interest rates demanded by investors in U.S. Treasuries, and cause an instant loss of principal for those hapless investors (like the Chinese) who already own U.S. Treasuries. Buying U.S. Treasuries – which used to be considered a “riskless” investment – is now anything but. The U.S. government has abdicated its throne as the king of low-risk credit. If buying U.S. Treasuries is no longer a safe way to invest money, what is a conservative investor to do?

Invest in the new king of low-risk credit: U.S. investment-grade corporate bonds.

U.S. Investment-Grade Corporate Bonds are te New Sovereigns of Debt

Sovereign debt owed by a country’s government historically has historically been viewed as the safest form of debt because governments have the power to increase the taxes paid by their populations to ensure repayment. The global debt crisis, however, has caused governments to bail out their private sectors and assume all of the debt themselves, making sovereign debt owed by governments much more risky that it used to be. In a recently-released report by JP Morgan, chief U.S. equity strategist Thomas Lee argues that U.S. investment-grade bonds are the “new sovereigns” of the debt world and the best destination for low-risk investment capital. He supports this assertion by demonstrating that 22% of U.S. investment-grade corporate bonds have lower five-year CDS spreads than U.S. Treasuries. In other words, the market is telling us that the U.S. government has a higher risk of default than blue-chip U.S. companies. Amazing.

Below is a list of ten U.S. corporations with CDS spreads below that of the U.S. government, equity free-cash-flow yields greater than their bond yields, and which have earned an “overweight” rating from JP Morgan. I also provide the ten countries with the lowest CDS spreads:

Lowest-Risk CDS Spreads: Corporates and Governments

Source: JP Morgan, Bloomberg 

For some reason, my Bloomberg terminal didn’t offer a CDS quote for Canada, but I would be very surprised if Canada didn’t qualify for a spot in the top ten. In case you are wondering what some of the worst government credits are, check out the CDS spreads on Greece (1681.33), Venezuela (972.18), Portugal (965.33), Ireland (836.67), and Argentina (601.39).

Buying individual corporate bonds can be difficult for two reasons: (1) each bond requires a minimum investment of $1,000; and (2) the bid/ask spread charged by dealers can be very wide if you are not an institution. Consequently, a more realist alternative for the average investor is to buy an exchange-traded fund (ETF) that holds investment-grade corporate bonds. Below is a short list of ETFs that specialize in investment-grade corporate bonds:

Investment Grade Corporate Bond ETFs

Invest in Income ETFs with the Help of Global ETF Profits

Global ETF Profits co-editors Ben Shepherd and Yiannis Mostrous focus on low-cost ETFs and ETNs that are most likely to outperform the overall market – both equity and fixed income — going forward. They are not “index huggers” but try to beat the market with their contrarian take on the best industry sectors. In fact, Ben and Yiannis have identified 25 ETFs in a multitude of different sectors that are in buy range right now.  

To find out the specific names of all of Ben and Yiannis’ favorite ETFs, consider giving Global ETF Profits a try today!