Buying into corporate bonds in the early stages of an economic recovery is an exercise in picking the best fruit on the vine.

Every company has its own financial situation and every corporate bond has distinctive calls and covenants. And when it comes to sectors, shopping for credit-sensitive bonds requires a market call.

Some clients will look for advantageous spreads over federal bonds, while others will shop sectors on the theory that a return to growth will affect some sectors, such as materials, differently than it will affect sectors such as financial services or consumer discretionary.

Financial services companies’ bonds make up more than half the investment-grade bond universe, says Chris Kresic, senior vice president with Mackenzie Financial Corp. in Toronto: “Financials were hurt the most, in percentage terms, during the financial crisis. For terms of five years, yield spreads on their senior debt went to 250 basis points over federal bonds from 30 bps. Subordinated debt was up as much as 350 bps over federal bonds.

“With that kind of discount, there ought to be a bounce-back when liquidity returns to the market, even if economic fundamentals are still problematic,” he predicts. “Illiquidity is a quarter of the spread, and there are fewer buyers than there were a year ago. As the financial system improves, there ought to be some relief in the market.”

The bargains are not hard to spot. For example, in financial services, a Honda Canada Finance Inc. 5.076% bond due May 9, 2013, has recently been priced at $95 to yield 6.41% to maturity.

Next to recover could be consumer discretionary bonds, such as the Canadian Tire Corp. 5.61% issue due Sept. 4, 2035; it was recently priced at $68.50 to yield 8.65% to maturity.

In the energy sector, a Suncor Energy Inc. 5.39% issue due March 26, 2037, has recently been priced at $69.80 to yield 8.15% to maturity.

Materials should recover in the later part of the business upturn, Kresic says. One possibility is copper and gold producers, such as Freeport McMoran Inc. ’s 8.375% bond due April 1, 2017, which was recently priced at US$65 to yield 16.3% to maturity.

In real estate development, in which companies are often heavily leveraged, there will also be a later-cycle revival. For example, a Brookfield Asset Management Inc. 5.95% issue due June 14, 2035, with an investment-grade rating, has recently been priced at $50 to yield 12.38% to maturity.

“I am not rushing to buy any of this,” Kresic says. “I want to see the economy on a firmer footing before I buy. But it is not a bad time to start piecing together a bond portfolio of high-quality issues at what we used to think of as junk-bond prices.”

Advisors are getting ready for the rotation into corporate issues. “We can agree that regulated utilities, including pipelines, have had the least stress; they have consistent and predictable cash flows,” says Daniel Stronach, who heads Stronach Financial Group Inc. in Toronto. “A lot of my clients have moved from a 15% weighting in corporates in their bond portfolios to 70%. They want to be ready to capitalize on strong companies that have suffered more than they should have on their ratings.

“Among the beaten down,” he suggests, “is General Electric Co. , probably because it owns GE Capital, a business that was on the front lines of innovation in financial products and is now suffering for it.”

However, the same brush has been used to paint many other bonds. For example, Ontario’s Hydro One Networks Inc. , which is a financially strong utility. “Taking some chances on investment-grade corporates,” he adds, “makes sense to me.”

Stronach’s argument is that with spreads of more than 400 bps on BBB bonds over federal bonds, the combination of yield plus capital gain in recovery will be 12%-18%.

But timing the moves out of government debt and into corporate bonds will be key.

“The market tends to lead the economy by six months,” says Jackee Pratt, vice president and portfolio manager with Mavrix Funds Management Inc. in Toronto. “So, that is the time frame for which you would have to plan ahead.” IE