Long Term Perspective

Equity investors know that various sectors of the economy perform differently over the business cycle. Thus, stock prices will ebb and flow with or against economic activity. Similarly, bonds in various sectors of the economy will bear different risk levels, just like stocks, depending on the pace of economic activity. For instance, among this group (services and consumer), consumer sector bonds offered lower yields than the service sector since 2000, probably because these were viewed as having lower risks of default over the time horizon. The gap narrowed dramatically versus each other and relative to the 10-year note yield in 2003, likely reflecting a strengthening in quality (lower default risk) in services bonds relative to consumer sector bonds. However, both lost ground in terms of risk relative to the 10-year Treasury bond during 2006 as the Fed’s tightening during the first half of 2006 raised the default risk for the private sector bonds that continued into early 2007. Subprime worries during the second half of 2007 led Treasury rates to decline relative to services sector and consumer sector bonds.

Short Term Perspective

Spreads widened in 2005 and 2006 and in late 2007. The spread between service sector bonds and the 10-year Treasury note increased to 117 basis points in 2006 from 97 basis points in 2005. Similarly, the spread between consumer bonds and the 10-year Treasury note increased to 91 basis points in 2006 from 67 basis points in the previous year. More recently, the spread for the services corporate bond and the consumer corporate bond in November stood at 161 basis points and 115 basis points, respectively.

Corporate yields fell 16 and 27 basis points for services and consumer sector bonds, respectively, in November while the 10-year Treasury note yield slipped 38 basis points.