Corporate bonds making comeback

— -- Investors impressed with the stock rebound might be even more amazed with the bounce in corporate bonds.

Coming off a credit crunch that almost froze corporate borrowing activity, the bond market has thawed rapidly this year as faith in the economic recovery has helped get funds flowing through the financial system again.

"The capital markets are working," says Bill Larkin of Cabot Money Management. "The market is looking at data points and saying the problems are getting behind us." Bond experts see several trends indicating improved credit conditions, including:

•Dramatic drop in interest rates on bonds sold by companies. The gap between yields on corporate bonds and government Treasuries is a key measure that bond experts watch for signs of credit healing. When the gap narrows, it shows investors are more willing to lend money to companies. And the difference has been coming down fast. Yields on bonds issued by the companies with the lowest credit ratings are 9.6 percentage points above Treasuries with similar maturities, says Merrill Lynch, down sharply from an 18.1 percentage-point difference at the end of 2008.

•Stabilization in companies' health. The number of the shakiest companies, called weakest links, has not only stopped rising, but is starting to fall. There are 285 companies with the lowest ratings and outlooks from Standard & Poor's, meaning they are the most likely to have serious financial troubles. That's down from 290 in June and a record 300 in April, S&P says. Much of the decline is because many of the shakiest companies have already defaulted on their debt and fallen off the list. But the fact more companies haven't taken their place is encouraging, says S&P's Diane Vazza.

•Ready appetite for flood of corporate bonds. U.S. companies have raised $903 billion this year in the debt markets through June, up from $548 billion in the same period last year, says BondDesk Trading: Data & Analytics. The proceeds this year are even higher than the $651 billion raised the first half of 2007.

Investors remain interested in corporate bonds even while the government sells large amounts of debt. The Treasury sold $42 billion in two-year notes on Tuesday in the biggest offering since the auctions started in the 1970s, Bloomberg News says.

Certainly, it's too early to pronounce the credit crunch dead, says Josh Stiles of bond trading firm IDEAglobal. Companies with lower credit ratings have seen their rates fall, but they're still well above levels at the end of 2006.

"We getting closer to normal, but we're not there yet," Stiles says.