Among the astounding aspects of the market’s recovery since March 2009 has been the huge disparity in performance between low-quality and high-quality investments.
Consider this chart produced by Russell Investments. It demonstrates the relationship between the quality of publicly traded companies—based on their S&P debt ratings in 2009—and their stock performance.
Companies rated below BB (effectively junk status) averaged returns of 85%. Companies with AAA ratings had an average return of just 9% during the same time period.
This relationship between perceived investment quality and actual returns was also exhibited in the U.S. bond market in 2009. Here, the returns generated by the lowest quality bonds, are incredible.
Going back to the first chart, look at the gray bars for fourth quarter performance as it compared to all of 2009. The lower rated companies still outperformed higher rated companies on an absolute basis (with companies below BB increasing by 12%). However, as a percentage of their total return for 2009, the highest rated companies had the best returns during this quarter. In fact, among AAA-rated companies, 8% of the 9% of return for the year was generated in the fourth quarter alone.
We very much believe in the concept of reversion to the mean. In global stock markets, this experience already has begun as large cap “value” stocks have regained a bit of favor so far in 2010. Bond market expectations are a bit different. We don’t expect the safest bonds, U.S. Treasuries, to post the best returns. In fact, they are not very attractive. Investment-grade corporate bonds, those rated BBB and higher, could offer meaningful returns for their assumed level of risk. Junk bonds, however, are not likely to continue to produce returns so far ahead of their long-term averages.
