Pointing to value

chart of the month

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This chart shows how credit spreads have been performing versus share prices, and might help investors spot relative-value opportunities

The chart below supplied by JPMorgan, shows how credit’s various sectors have performed in the equity and credit market relative to the industrial universe since the start of the year.

The horizontal axis shows the excess spread over the ‘rock bottom’ spread relative to the average in the corporate bond market (excluding financials). The rock bottom spread is the minimum spread over Libor that investors require to be compensated for underlying default risk. Anything over and above this spread is often interpreted as a liquidity premium. For the vertical axis, Dirk Muench, European credit strategist at JPMorgan, looked at the performance of the bond issuers’ equity in each sector. To compare like for like, each sector’s equity performance is calculated using bond market weights and is again showed relative to the whole industrial universe.

By plotting each sector’s position on two dates (in this example, January 5 and April 20 this year), one can track the movements of the sectors against default risk and equity markets. Over any period, an arrow pointing from right to left shows that excess spreads have tightened relative to the industrial universe. A vertical movement indicates that the relevant sector has experienced a re-rating in the equity market. In this particular case the chart therefore shows the weaker equity performance of the cyclical sectors in the first quarter of the year as excess spreads remained more or less stable.

To give an example of how this chart might be interpreted, one can consider an upward movement combined with a rightward movement. This might indicate a relative-value opportunity, between credit and equity, as the sector performed well in the equity market (upward movement) and its bonds cheapened in the credit market (rightward movement).

However according to Muench, the chart cannot be viewed in isolation. While it provides valuable support in understanding sector performance by linking equity and credit markets, any indication of relative-value opportunities needs additional analysis and interpretation.

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