Nov

18

One speculates after seeing the high correlation to change in bonds issued for the year and the index, if there is a more predictive correlation when an individual corporation issues more new bonds and their stocks return. Are there good studies on this?

I also looked at the ratio of junk issued to total for the year and thought there may be a positive correlation to performance of Russell 2000 vs S&P. However, there was a fairly strong negative correlation. The S&P generally outperforms Russell 2000 when there were a high percentage of junk issued, perhaps because the junk issuer is forced to. Which again could use a good individual stock study.

It would seem that one of the lessons to this crisis is that keeping an eye on and understanding the too liquid and subsequent illiquidity in the bond markets is key seeing the "fat tail" or "black swans" like John Paulson.

Year LN Change LN Change in S&P in US Corp Index Bond Issued
10/2009 13.7% 12.3%
2008 -48.6% -46.8%
2007 3.5% 6.3%
2006 12.8% 34.1%
2005 3.0% - 3.6%
2004 8.6% 0.6%
2003 23.4% 19.8%
2002 -26.6% -19.8%
2001 -14.0% 27.8%
2000 -10.7% - 6.9%
1999 17.8% 3.0%
1998 23.6% 27.0%
1997 27.0% 30.4%

For the bond issuance data:

http://www.sifma.org/uploadedFiles/Research/Statistics/SIFMA_USCorporateBondHYIG.pdf

 Jordan Neuman responds:

I don't know if full year returns sufficiently catch what you are looking for. It seems that Junk Bonds are issued when they are in demand, after a small-cap (or "risk") run. Then the S&P out performance makes sense as the cycle changes. The Russell 2000 is still about even with the S&P this year, but has gotten trounced on a relative basis only lately.

Russell Sears responds:

In my theoretical way of thinking, generally new debt is issued when there is either a change in perception of risks (increase leverage) or new opportunities for profits (expand empire). However, with junk it not as clear where the "equity" line is. It may be that junk needs more dissecting than simply "junk". It is not clear which stocks or bonds come first the chicken or the egg. Also, for the list only, I suspect that perhaps an early warning sign may be if the debt is under or over subscribed at issue. However, debt or mbs bonds especially in the sub-prime area signaled over issuance and too high a demand that a bubble had formed well before it broke.. AAA stuff was being sold as risk free arbitrage where you simply hedged out the duration or interest rate risks then leverage it up high enough to get whatever return you wanted. It had to end badly.


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