“We are recommending a move to overweight the corporate sector, shifting to an underweight position in long Canadas,” it says in a new report. “Several factors would argue for a rotation into corporate bonds: spreads are at very attractive levels, equity markets continue to rally — suggesting an increasing appetite for risk, growth in the U.S. may well beat expectations next year, and Canadian corporate earnings are in the midst of a solid recovery. With yields likely to rise, we also recommend trimming duration.”

Nesbitt says that the U.S. economy seems to have passed through its ‘soft spot’ and be on its way to recovery. “Even though the Federal Reserve cut rates by a further 50 basis points last month — magnifying concern over a potential double-dip — more recent data suggest better times lie ahead. Retail sales have firmed, manufacturing may have turned the corner, the job market is no longer deteriorating, and equity markets have staged a two-month rally. This suggests that bond yields are likely to continue rising,” it says.

“As Canadian bonds had not rallied as enthusiastically as Treasuries, the recent back-up in rates has not been as sharp north of the border. The upward pressure on yields in both countries has come from an eight-week rally on stock markets and firmer economic signals, prompting portfolio rebalancing toward equities,” notes Nesbitt.

Corporate spreads continued to improve in November, reports the firm. “Financial issuers traded up to 15 basis points tighter and autos were marked in 50 basis points while Ford Credit tightened about 150 basis points. We also started to see buyers of oil and gas names for the first time in a while. Issuers in the electric utility sector suffered mid-month from negative headlines, continued uncertainty and rating agency concerns, but bounced back to participate in the spread tightening as well. We expect the relatively high cash levels associated with the December 1st coupon and maturity payments to keep a strong bid in the corporate bond market.”