January 11, 2011

Ho, Ho, Ho Hum: Despite Rising Yields, Bond Trading Stayed Low

Wall Street was brimming with holiday cheer during December. The so-called “Santa Claus Rally” was in full effect, as each major stock index (S&P 500, DJIA, and NASDAQ) increased 2% or more. The catalyst for the rally was President Obama’s extension of the Bush era tax cuts, which the markets unanimously hailed as a positive sign for the economy.

As investors increased their appetite for risk and piled into the stock market, the safety of Treasuries lost some of its appeal. This prompted a big selloff during the first half of the month, driving yields up over 50 bps in two weeks.

That increase flowed through directly to the corporate bond market, where yields also rose substantially during the first half of December. This was the second straight month corporate yields increased, which hadn’t happened since April. (Note that the stock market rally also put downward pressure on corporate spreads in December because there was less concern about credit risk, but that effect was swamped by the yield increases in the Treasury market.)

In spite of the increased yields, trading volume among individual investors was light in December relative to 2010 averages. Selling activity on the other hand remained elevated. The buy/sell ratio edged up to 1.1 from November’s 2010 low of 1.0, but that’s still substantially below the 2010 peak of 1.7. (Note that we expect to see more buy trades than sell trades in the retail fixed income market because individual investors frequently hold bonds to maturity and thus never sell them, which is why a ratio near 1 is unusual.)

Both buying and selling volumes were steady for most of December before falling precipitously during the end of the month. Trading activity normally tracks yield movements pretty closely, so it’s not surprising that volumes tapered off as yields fell. But given the extreme decrease in late December, it seems investors were more concerned with their holiday plans than their bond portfolios.

Financial firms remained the bonds of choice among individual investors in December. A whopping 57% of all investor buy transactions were financial firms. That’s not surprising, given that financial firms were paying the highest yields in December. The median 5-year, “A” financial bond yielded 4.0%, while the median “A” industrial bond yielded 2.5% – a difference of 150 bps. In November that difference was only 140 bps, so the gap grew in December.

For more information about retail trading activity in the corporate bond market during December, please see the complete BondDesk Market Transparency Report.

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