Since trading north of 4.81% last Friday, three-month LIBOR has plunged 98 basis points over the last few days to 3.83% this morning in London. Credit markets continue to ease as interbank lending continues to grow following weeks of a virtual shutdown.

The good news is that further easing of LIBOR should pave the way for a rally in non-Treasury bonds, hammered to historical lows since mid-September. There’s solid price action over the last several days in investment-grade corporate bonds; still, I would avoid high-yield or junk bonds and emerging market debt. But investment-grade debt is pretty cheap and pays an average yield of 8.86%, according to the Dow Jones Corporate Bond Index. That’s the highest yield in years and almost 500 basis points more than ten-year Treasury bonds.

If investment-grade debt continues to rally, stocks might also get an additional boost at a time when earnings look poor. From its low on October 10, the S&P 500 Index is now up 9.6%.

The stock market now faces challenges from a traditional friend or foe -- corporate earnings.

I don’t expect good numbers to appear as we begin Q3 reporting in earnest this week; the majority of companies are warning about the next three months and this will probably temper any big gains for stocks. This is a bear market rally and should be viewed as a temporary recovery, not the beginning of a bull market. Corporate earnings and credit stress are still evident worldwide, seeping into corporate earnings forecasts and bound to cause more dislocations over the next 3-6 months.

On the positive front, crude oil and commodities prices have collapsed since July. That’s bullish for companies’ input costs. Yet apart from lower oil prices, consumption is heading lower just about everywhere in the major and emerging markets. China just announced Q3 GDP growth of just 9% -- its weakest GDP growth since 2002. A slowing Chinese economy means lower, not higher, commodities prices, at least for the next 3-6 months.

Weak or sluggish commodities prices should also benefit high-grade corporate debt.

Corporate bonds are worth buying at these distressed levels. They pay fat yields, have plunged more than 15% since September and compared to government debt, are much cheaper. They should also hold up well as the market transitions from credit stress to corporate earnings concerns.

Most of the ETFs in this sector hold a big chunk in financial services or bank investment-grade debt. Many of these issues are now guaranteed by the United States government. If that’s the case, then why would I want to own a T-bond yielding barely 4% when I can buy AA or A corporate bonds paying more than 8%? The corporate bond ETFs in New York yield less, about 7% over the last 12 months. Still, after a virtual slaughter, I’d rather own corporate bonds, not T-bonds. In fact, I prefer corporate bonds to most stocks.

I’m increasing my holdings of corporate investment-grade debt while betting against long-term Treasury bonds with a reverse index as U.S. Treasury’s are overvalued and poised to suffer from higher interest rates over the next 6-12 months.

High-grade corporate bonds are likely to outpace government debt over the next five years, barring another major credit crisis. That’s because government debt is set to explode higher amid historical bailouts and guarantees; that implies higher interest rates, especially in the United States and Europe. It might be possible that even if there is a total breakdown of the European single currency over the next few years, which I expect, investors might shun Italian or Greek debt in favor of HSBC or Nestle. They might also bypass German bonds, too.

Corporate debt, on the other hand, remains at the opposite spectrum with many non-financial issues still flush with cash and even bank debt now guaranteed by the government. For 2009, I like investment-grade bonds and ETFs.