Government bonds flourished as commodities and equities plunged in 2008. But Theo Casey says a new bull market in corporate bonds could soon take its place. As investors seek higher returns than Treasuries, demand for high-grade corporate debt, particularly if backed by the government, could soar.

This from Fleet Street Invest:

According to one old investment adage, “there’s always a bull market somewhere.” If it isn’t in stocks, it’s in commodities. If not commodities, then bonds, and so on.

Despite the seemingly inescapable credit crunch, that truism lives on today. While stocks and commodities have been pummeled, government bonds have been shining. An almighty flight to safety led investors from stocks, commodities and property markets to cut their losses, sell up and retreat to the safety of “risk-free” government bonds.

That bull market could come to an abrupt end sooner than many were expecting. In its place a new bull market in corporate bonds is building up steam.

Government yields are practically zero

Despite the guarantees across market sectors across international regions, it has been incredibly tough to convince investors, banks and pretty much all market players to put their cash into risky assets, like shares.

According to Société Générale, cash rich companies and investors alike have been seeking the safety of the short-term government debt market. In so doing, as is always the case with too much demand, the yields on these bonds has been pushed to dramatic lows. The yield on 3-month gilts is just 0.92%, down from 4.3% 12 months ago, and interest rates are still falling. That means that any new bonds issued by the Debt Management Office will carry even lower yields.

In the US it’s even worse, with yields on the equivalent bond actually at a pathetic 0.11%. Such was the fear in the market, investors were willing to earn just $1 for every $1,000 invested, effectively just parking money in a safe and liquid place.

While appropriate in the wake of the Lehman Brothers collapse, this behaviour no longer makes sense.

Risk-free cash is earning zero interest. The desire for some return will force investors to seek other places for their money. However, this is not a reason for stock market investors to get excited. It’s unlikely that the money market crowd is going to make the extreme leap from risk-free bonds to stocks. This could, however, be good news for the middle ground, corporate bonds.

Why good quality company debt could be an outstanding opportunity

When bond yields are so low, and investors are less panicked, they begin looking for higher yields again.

Sensing a turn in the market, corporate bond issuance soared last week to its highest weekly tally in 8 months, Bloomberg data show, with $41 billion worth of bonds issued. Last week’s tally was roughly double that seen before the credit crisis began, and roughly equal to the tally for all of last September and October when the credit markets froze. And, as bond specialist Tony Crezcensi from investment firm Miller Tabak notes, “there were a host of companies selling to yield-hungry investors.”

So what’s the smartest play on this trend? Don’t go straight in, dip your toe into the risk pool by following the Government. Look at government guaranteed bonds such as Lloyds TSB or Nationwide. I’m no bank bull, but if these companies boast the same guarantees as a government bond and offer better yields, it seems like a good opportunity. These bonds carry a AAA credit risk rating and offer 4.2% and 4.6% more yield respectively.

Without risk, there is no return, and right now that is truer than ever. Today, the only reason to stay in the government bond market is irrational fear. As investors get a little bit braver and a little bit greedier, a bull market in corporate bonds could form in 2009.

Source: Why Corporate Bonds Could Be The Trade Of 2009