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Credit Spreads Aren’t a Reason to Alter Bond Allocations

A year ago, I wrote about why I favored corporate bonds instead of government bonds. I revisited the subject this week after doing my semiannual review of my workplace retirement savings account.chart

One of the funds I hold in my 403(b) account is the Vanguard Intermediate-Term Investment-Grade Fund Admiral Shares (VFIDX). As the name implies, it invests in higher-quality corporate bonds. These bonds are riskier than Treasury bonds with similar maturities because there is a greater chance of a corporate issuer defaulting. The risk of default among investment grade bonds is nowhere near as high as it is for high-yield (aka, junk) bonds, but U.S. government bonds are still the safest.

The reason I took a second look was credit spreads. A credit spread is the difference in yield between a safer and riskier bond of similar maturity. It’s helpful to think of spreads in terms of insurance premiums. Insurance companies charge more if they think there is a greater risk of having to pay out on a policy (e.g., because a person has had a few traffic violations). Similarly, bond investors demand higher yields if they think there is a greater risk of the bond issuer defaulting. Depending on the prevailing economic and risk-taking environment, credit spreads can narrow (less difference between the yields for safer and riskier bonds) or widen (a bigger difference between the yields for safer and riskier bonds).

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Earnings season remains in full swing with nearly 140 S&P 500 companies scheduled to report. Included in this group are Dow Jones industrial components: Coca-Cola Co. (KO) and Pfizer Inc. (PFE) on Tuesday; Apple Inc. (AAPL) and DowDuPont Inc. (DWDP) on Thursday; and Chevron Corp.(CVX) and Exxon Mobil Corp. (XOM) on Friday.

The week’s first economic report will be September personal income and outlays, released on Monday. Tuesday will feature the August S&P Corelogic Case-Shiller home price index and the Conference Board’s October consumer confidence survey. The October ADP employment report and the October Chicago Purchasing Managers’ Index (PMI) will be released Wednesday. Thursday will feature preliminary third-quarter productivity, the October PMI manufacturing index, the October ISM manufacturing index and September construction spending. The October jobs data—including the change in the nonfarm payrolls and the unemployment rate—as well as October motor vehicle sales, September international trade and September factory orders will be released on Friday.

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