Here’s the good news: Europe’s corporate-bond market has produced excellent returns this year. Unfortunately, that’s also the bad news.
 
Corporate bonds have beaten stocks in Europe hands down this year, with the Markit iBoxx investment-grade corporate index up 7.7% in the year to date, while the Stoxx Europe 600 has gained a meager 2.3%.
 
Moreover, corporate bonds have displayed little of the volatility that has bedeviled stocks. During October’s turbulence, bond prices barely budged as equity markets swung wildly.
 
At most, corporate-bond yield spreads over haven government-bond yields widened 0.1 percentage point even as stocks fell by 10% before rebounding. The resilience of the corporate-debt market ultimately was a good signal that the panic in stocks was overdone.
 
But the relentless rally in European corporate bonds comes at a price: The yield on Markit iBoxx’s investment-grade euro-denominated corporate-bond index, which has a maturity of 5.4 years, is at a record low of 1.42%. Many bonds yield much less than that. Of the roughly €760 billion ($952 billion) of nonfinancial corporate bonds that are part of that index, 52% yield less than 1%, UBS credit strategists note.
 
Just 13% yield more than 2%. Issuance of investment-grade bonds with coupons of more than 2% has become a rarity—even at long maturities. Apple was recently able to issue a 12-year euro-denominated bond with a coupon of just 1.625%.
 
That will create a real headache for investors next year. Mathematically, given the starting point of ultralow yields, the outlook for bond returns is poor. While government bonds have shown yields can turn negative, it seems unlikely corporations can hope for similar generous treatment from investors.
 
That doesn’t mean the bond market is about to crater. The economic outlook for the eurozone is weak, inflation is low and the European Central Bank is still in easing mode. Moreover, speculation that the ECB could expand its program of asset purchases to include corporate bonds is likely to keep the market buoyant. Corporate balance sheets are still in decent shape. And investors worried about the volatility of stocks could yet prefer the smoother ride that bonds are likely to offer.
 
Even so, that reassurance will come at the cost of far lower returns than this year. European corporate bonds are now extremely expensive. They may make some small further gains yet. But investors shouldn’t hope for a repeat of 2014’s good news.