NEW YORK (MarketWatch) -- While U.S. corporate bonds have seen their best quarter in years, it wasn't as good as the show-stopping performance of U.S. equities, and some see this as a problem for an extended stocks rally.
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For the quarter to date, the S&P 500 index(SPX 928.86, +9.29, +1.01%) gained 15.2%, its best quarter since the three months ending in December 1998.
Corporate bonds, meanwhile, have jumped more than 11% this quarter, as fear and panic about the possibility of falling into a Depression subsided. That helped to lower their yields, which move inversely to price, but not enough to make them less attractive than stocks.
"The biggest challenge equities face at the moment may not be the economy, it's the triple-B corporate bond rate," said Jack Ablin, chief investment officer at Harris Private Bank, in a note.
When making asset allocations, fund managers often like to compare the earnings yield of the S&P 500 to the yields of other asset classes, such as Treasury or corporate bonds. The earnings yield is computed by dividing S&P 500 earnings over the past 12 months by price.
"At 7.9%, the yield of triple-B, 10-year corporate bonds towers above the 6.5% earnings yield sported by the S&P 500," says Jack Ablin. "It's disturbing that the differential is as wide as it is. From an earnings yield perspective, either corporate bond prices need to rally or earnings estimates need to improve in a hurry."
On Tuesday, the S&P 500 fell 7.9 points, or 0.8%, to 919. The Dow Jones Industrial Average (INDU 8,548, +101.05, +1.20%) slumped 82 points, or 1%, to 8,447, while the Nasdaq Composite (COMP 1,857, +21.58, +1.18%) fell 9 points, or 0.5%, to 1,835.
Besides the S&P's 15% advance, the Dow industrials rose 11% and the Nasdaq jumped 20% during the second quarter. But the month of June was underwhelming. The Dow fell 0.6%, the S&P was unchanged, and the Nasdaq rose 3.4%.
Stocks have started to sputter over the past month, with investors - now satiated with 'not-as- bad-as-expected' economic news - wanting actual improvements. The second quarter earnings season, however, is expected to show another big drop in earnings, not a good omen for the S&P's earnings yield, says Harris Trust's Ablin.
"If these spreads [between corporate and earnings yields remain], it's going to be difficult to make money in stocks," he said. "Corporate bonds are offering a very attractive alternative to stocks going forward."
Treasury prices, meanwhile, have fallen during the quarter as investors fled the safety of government debt. Bond holders also began pricing in some concern over inflation while government debt issuance also helped reduce the value of current holdings. Ten-year note yields (UST10Y 3.54, +0.01, +0.40%) have increased from 2.69% at the end of March and reached 4% earlier this month. See Bonds.
Among other asset classes, commodities have also seen huge runs during the quarter. Oil, for one, rallied 41% in the second quarter, the biggest quarterly gain since Saddam Hussein's invasion of Kuwait in the third quarter of 1990. See Futures Movers.
Gold rose 0.4%. See Metals Stocks.
Nick Godt is a MarketWatch reporter based in New York.
