Strong reasons why investors will put their faith in bonds

--High quality bonds a safer bet than volatile equity --Lower inflation and even concern over delfation makes bonds attractive --Many high quality bonds yields at historic high levels. The chance they will get downgraded remain slim. --record dire econmic data, unemployment & sales & auto & ISM manu and service index, and changing economic policy increase the downside risk while tighter regulation, continuing deleverage lower the upside risk of equity. --It is tempting to assume stock market priced in the bottom but it might be a prolonged recession and the the intertwined capital market might not have priced in foreign bottoms. --Yield for high qualities bonds are recovering. It will be better to find out the trading volume in secondary market. By Michael Mackenzie in New York Published: December 6 2008 02:00 Last updated: December 6 2008 02:00 Choosing between equities and high quality corporate bonds is not difficult at the moment. As the equity market struggles to find its footing in an environment of extreme volatility, the generous yields on offer from good quality corporate bonds look a safer bet right now than equities, argue some investors. Mark Kiesel, portfolio manager at Pimco, says the asset allocation choice between fixed income and equities comes down to owning high quality corporate bonds, that is, those that currently offer expected returns normally associated with equities. "Investors should buy credit now and equities later," he says. "Over the past 20 years, the S&P 500 has returned only 2 per cent more than the investment-grade corporate bond market, yet with nearly three times the volatility." Volatility remains the defining characteristic of the S&P as it tries to find its footing amid its worst bear market since the 1930s and the stunning loss of 533,000 jobs in November. The S&P's low last month reflected a drop of 52 per cent from its record closing high set in October 2007. Only the slide of 54.5 per cent in 1937/38 and the 83 per cent plunge during the 1930-1932 period have seen bigger bear market falls. In spite of this week's dire economic data, the S&P stands more than 16 per cent above its recent low. The big drop in mortgage rates and petrol prices is helping to make the case that a bottom has been made in stocks. Then there is precedent. Earlier this week, the National Bureau of Economic Research in its capacity as the official arbiter of calling recessions, said the US economy began sliding in December 2007. So, at a year and counting, some people are hoping that if the current downturn emulates the 16month recession of 1981/82, a recovery could be just around the corner. The trouble is that there are plenty of reasons for thinking that the current recession could become a lot worse than that of the early 1980s. While stocks have arguably priced in a lot of pain, there is no guarantee that when they climb up from the canvas, they can stay on their feet. Indeed, Ben Bernanke, chairman of the Federal Reserve, hardly calmed the market's nerves this week when he suggested that the central bank could purchase long-dated government bonds in order to drive down yields - thus helping struggling home owners refinance their mortgages at lower rates. Being positioned for a low inflation environment that could potentially usher in deflation supports top quality bonds, whose fixed rate coupons are eroded by rising consumer prices. In contrast, a look at Japan's stock market, which remains a shadow of its 1989 glory, shows what deflation means for equities. Fixed income investors are already casting their vote. Treasury yields have plumbed historic lows and the average yield for AA rated corporate debt has fallen one percentage point towards 6 per cent since mid-October. Lower down the spectrum of investment grade debt, Moody's index of corporate bonds rated BAA, currently shows an average yield of about 8.8 per cent. That's down from a peak of 9.54 per cent at the end of October and at current levels this type of debt remains above the 8.25 per cent ceiling recorded during the wave of corporate bankruptcies in 2001 and 2002. In other words, investment grade credit has more than priced in a period of severe corporate distress. If investors accept the forecast currently painted by inflation linked bonds, these type of investment grade yields look positively stellar. In recent weeks, prices of Treasury and inflation protected securities imply that the US will experience deflation for at least five years. But only during the early 1930s has such an episode occurred. Jack Ablin, chief investment officer at Harris Private Bank, says if the Treasury market's pricing of inflation risk holds, "an 8.8 per cent yield is pretty compelling competition for stocks". That could leave stocks twisting in the wind for a while yet. "Stocks can't go up until corporate bonds recover," adds Mr Ablin.