While the term "corporate debt" might make your eyelids start feeling heavy, there's a few tasty reasons that investors from all walks should be following developments from this slice of the financial markets.
Getting straight to the point, when companies want to raise funds, one option available to them is to issue bonds. Investors hand over their cash and in return get an IOU and in some cases an income stream in the interim (known as coupon payments).
That means corporate bond investors have a vested interest in seeing the companies they invest in continue to exist. Not surprisingly, the perceived financial strength of a company's balance sheet and continuing business prospects play a role in how much they pay to access debt.
In this regard, the value of corporate debt investments can fluctuate based on the current economy and expectations for the future economy. As observed during the Great Recession, when the economic outlook plummeted, corporate bond prices also took a big hit.
Because governments are less susceptible to "bankruptcy," government bonds tend to outperform corporate bonds during times of high anxiety. Therefore, watching the spread between corporate and government debt can provide valuable insights to investors from all corners of the financial world.
The slide below illustrates how spreads can widen between corporate and government bonds during periods of economic stress (i.e. 2008-2009):
Seeing spreads widen, as they did from 2008-2009, is therefore an important signal to watch for.
There are other aspects of the corporate debt market that are equally captivating. Given that the corporate debt market suffers when the economic outlook deteriorates, one would think it might also be correlated to equity prices.
Fortunately, a recent episode of The Skinny on Options Data Science provides data on this very subject. Looking at some ETF proxies for equities (SPY), corporate debt (HYG), and government debt (TLT), this episode shows measurements of correlation between the three in recent years.
That data reveals that SPY and HYG are the most correlated (of the three), and especially so from 2010 to present. Depending on your risk profile and approach, this information may allow you to further evaluate opportunities in these products.
For example, if you found your portfolio leaning short volatility, and HYG screened cheap in terms of Implied Volatility Rank (or another metric you use), you might be able to add some long HYG volatility to balance your exposure with another high-probability position.
If nothing else, following corporate and government debt through HYG and TLT (or similar products) may help you identify additional opportunities in the market, or better risk-manage your existing strategy.
Watching the full episode of The Skinny on Options Data Science should provide an even more comprehensive understanding of the topics covered in this post.
If you have any continuing questions about corporate debt we hope you'll reach out directly at firstname.lastname@example.org.
In the meantime, happy trading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.