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).