dinsdag 29 september 2015

Investment Grade Credit Risk Vs. Buybacks

Investment grade credit spreads are a leading indicator for buybacks. Buybacks are correlated with the stock market.

A credit spread is the difference in yield between two bonds of similar maturity but different credit quality. For example, if the 10-year Treasury note is trading at a yield of 2% and a 10-year corporate bond is trading at a yield of 4%, the corporate bond is said to offer a 200-basis-point spread over the Treasury.

As credit spreads rise, it gets more and more difficult to finance buybacks (credit conditions are worsening). Yields on corporate bonds go up (which coincides with a credit spread rise), which means that debt issued by the company (to buy back its own shares) has a higher interest rate. The result is that there will be less buybacks. There is a lag of 3 months (we borrow and then we spend).

Investment Grade Credit Spread Vs Buybacks

As buybacks are correlated with a rise in the stock market, we can assume that higher credit spreads are a leading indicator for lower equity markets with a lag of about 3 months.

So you could have predicted black monday in August 2015 (red graph) by looking at the rising credit spreads (blue graph).
A good way to predict recessions is to look at credit spreads between corporate bonds and treasuries.

The 30 year mortgage bond typically follows the BBB rated corporate bond yield.
The 10 year treasury bond typically follows the AAA rated corporate bond yield.

When these diverge from each other (for example in 2008 and in 2015), a recession is likely to occur as people flee from corporate bonds to the safety of treasuries.
For more info: https://pdfs.semanticscholar.org/e460/faf649cd2b43c5674dedcf45370973133c87.pdf

The credit spread between AAA rated corporate bonds and the 10 year U.S. treasury is a leading indicator for real GDP.

At this moment in 2019, we see credit spreads broadening (green line going down), which means that U.S. real GDP should be coming down as well (blue line going down).

It also pays to watch the CCC rated bond yields as they are always first to go bad.

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