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US corp bond laggards lead rally, more upside seen

By Dena Aubin

NEW YORK, Nov 20 (Reuters) - U.S. corporate bonds have come roaring back after a bruising October bear market, yet strategists say the market has more room to run.

Companies that led the market lower earlier this year have seen a run-up in their bonds, thanks to an improving stock market, signs of a profit recovery and investors' growing appetite for risk. Despite a still-gloomy outlook for credit quality, more gains are likely for once-troubled bonds as investors seek alternatives to low-yielding Treasuries and other safe securities, strategists say.

"The names and sectors that have been leading the rally are really the ones to go into at this point," said Vince Boberski, fixed-income strategist for RBC Dain Rauscher. "These names were trading well behind where their credit fundamentals indicated that they should."

Just last month, a wobbly U.S. recovery, worries about the health of consumers and a rash of downgrades to such prominent companies as Ford Motor Co. sparked a sell-off in corporate bonds. Investors dumped bonds with any credit risk, especially those with heavy debt to be refinanced.

"Bond prices were getting hit overtly for no good reason," said Daniel Genter, president of RNC Genter Capital Management LLC in Los Angeles. "Certainly, it's the right time to take advantage of the irrational depression."

Risk appetite for bonds was helped when Moody's Investors Service last week affirmed its ratings on No. 2 U.S automaker Ford Motor Co. and its finance arm, saying their liquidity was sound. Another turning point for the market was news last week that Britain's HSBC Holdings Plc was acquiring Household International , a consumer finance company plagued by worries about loan losses.

BIG BORROWERS REBOUND

The merger news sparked a stunning rally in Household's bonds, underscoring the risk in not owning the market's laggards.

"I got the impression that hedge funds and other people who had been playing against the credit market have decided they are not as willing to go short or be betting against credit," said Peter Palfrey, portfolio manager for Loomis Sayles & Co. in Boston. "Shorting" refers to selling bonds or buying credit default protection in anticipation of falling prices.

Relief from selling has helped. Corporate bonds overall have gained 1.92 percent this month, Merrill Lynch & Co. reported. That is the second-best performance of any fixed-income asset, behind high-yield bonds, which are up 4.07 percent.

Another big change in the market is a welter of new debt sales. More than 30 companies have surfaced with about $14.5 billion in corporate debt sales this week. Demand for those deals has eased worries that borrowers would lose access to capital and have trouble refinancing debt.

Companies hit earlier by refinancing fears have rallied strongly and should post more gains, said RBC Dain Rauscher's Boberski. They include automakers Ford and General Motors Corp., Household International, and phone companies Sprint Corp. and AT&T Corp., he said.

"The fundamental problems are still there, but it looks like the market has become less spooked about them and is seeing them in a little more realistic light," he said.

BARGAINS IN SHORT MATURITIES

Big issuers were shunned earlier in the year by investors wary of owning too much of a single company's debt. Yet those companies stand to benefit as investor sentiment improves, because their bonds are widely available and easier to buy, said Loomis Sayles' Palfrey.

Ford's bonds have enjoyed especially strong gains. Ford Motor Credit's 7.25 percent notes of 2011, which traded below 87 cents on the dollar in October, rose to 96 cents on the dollar on Wednesday, according to TRACE, the National Association of Securities Dealers' bond pricing service.

Investors acknowledge that corporate credit quality is not yet on the mend. Last month, Moody's downgraded 7.6 companies for every one it upgraded.

Still, signs point to a "gently recovering" economy, said RNC Capital's Genter, and that should benefit corporate bonds.

He finds value in four- and five-year maturities, where yields are generous and risks low. "You would have to have something pretty catastrophic happen for some of these companies to go out of business in five years," he said.