As the financial crisis has matured, so too has the coverage and commentary related to it. After so many shocks, few analysts are brave enough to call the bottom of this bear market. But we have now reached a point where many believe this is a rare opportunity to acquire high-quality investments at very good prices.

As the financial crisis has matured, so too has the coverage and commentary related to it. After so many shocks, few analysts are brave enough to call the bottom of this bear market. But we have now reached a point where many believe this is a rare opportunity to acquire high-quality investments at very good prices.

The truth, of course, is that nobody knows what will happen next in the markets. But this doesn’t mean to say that it is impossible to recognise significant patterns in the market and that some of the investment decisions made now based on this analysis could mark a defining point in a portfolio’s future performance.

By many measures, corporate bonds are now extremely attractive. Terrified by the uncertain corporate outlook, and therefore the prospect of default, investors have sought the safety of gilts. This has pushed the price of gilts up and their yields down. Conversely, the prices of corporate bonds have fallen and their yield has risen. It is this pattern of behaviour that means the widening gap between the yield of corporate bonds and gilts (the yield spread) is a useful indicator of investor fear.

The wider spread illustrates that investors are less willing to accept the default risk that comes with a corporate bond, and are prepared to pay a higher premium for the security of government debt.

This picture can also be painted in numbers. In almost 100 years, yield spreads have only been as high once before - during the Great Depression of the 1930s. Such extreme spreads mean the sterling corporate bond market currently yields close to 9 per cent. More adventurous investors can enjoy spectacular yields of 22.7 per cent in the European high-yield bond market. This is an 18.5 percentage point advantage over the region’s government debt issues. Buyers of fixed income now, therefore, will be locking-in very high yields.

This is a point reinforced by Ian Spreadbury, who manages sterling and European fixed income funds. He also points out that the added advantage of a well-timed fixed income investment is the potential for capital gain on top of the considerable yield. When investors do eventually regain their appetite for risk and so return to corporate bonds, prices will rise, spreads will narrow, and those that bought early will enjoy the capital gain alongside their high yield.

But this is not an unqualified call to fixed income, as risks do exist. First, there is the question of timing. However strong the buy signals, the point remains that it is impossible to know in which direction markets might travel next. Yes, spreads are at record levels, but corporate bonds may decline further before a recovery. The consensus among investors is that although we are well into this cycle, and have probably entered the final phase, there is plenty more bad news to come.

Some of that bad news will undoubtedly be a rise in default rates as companies succumb to the recession and are unable to maintain their coupon payments. But because markets are a proven discounting mechanism, some of this bad news is already priced in and early investors are being rewarded for their patience with the high yield. That default risk means bond selection with careful balance sheet analysis is vitally important, especially in the high-yield universe, in order to take advantage of the value.

What Does This Mean For Investors?

Income investors will be watching tumbling interest rates in horror as each bold step the Bank of England makes to save the ailing economy eats into their earnings. Growth investors are reeling from steep falls in asset values and some are now looking for the likely early winners as the cycle turns.

With economic growth in reverse and central banks slashing rates to stimulate a recovery, our asset allocation director, Trevor Greetham, believes we are in the reflation phase of the economic cycle. His analysis of decades of data points to bonds as the strongest asset class in periods of reflation.

While uncertainty still stalks investors and volatility remains the strongest characteristic of most asset classes, it seems sensible to maintain a broad spread of investments with the flexibility to tilt the allocation in favour of the strongest sectors and assets as we move through the economic cycle. There is also strength to the argument that mechanically drip-feeding money into the market, apart from taking the emotion out of the timing decision, can benefit from pound cost averaging and over time enhance the overall return.  Whatever their chosen method of adding money to assets, the value in bonds should be uppermost in the investor’s mind.