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Corporate Bonds, Derivatives, and How They Wag the Equity Markets


To more accurately guess the primary direction of equity markets, there are better places to look to than stocks themselves.

MINYANVILLE ORIGINAL Full disclosure: Much of what appears below I learned through the years from the writings of Brian Reynolds, now at Rosenblatt Securities, who is without question the sharpest bond market watcher I've ever run across.

Forgive the wonkiness of this piece, but I thought it would be helpful to explain why I often post on Minyanville's Buzz & Banter (subscription required) about the daily moves in the Credit Default Swaps (CDS) of large financial institutions and EU countries, the issuance of new corporate bonds, high-yield spreads, the two-year swap rates, the CDS on US debt, and other arcane derivatives.

These measures are always helpful to track the mood of the credit markets, but have been particularly critical over the last several years because the corporate bond market has been the primary source of funds to companies for buybacks, dividends, and M&A.

In addition, the bond derivatives market is where macro traders have been heavily involved to protect and/or press the downside of equity markets. Corporations have been the steady, relentless "bid" under equities absorbing the "sells" by institutions managing individuals' money. Pull up the quarterly Flow of Funds data by the Federal Reserve, and you will see what I mean.

So given the importance of fund flows from corporate bond sales, and considering that the S&P 500 (SPX) is at a juncture where an upside break could lead to more short covering in both equities and credit derivatives, it is useful to look back at some long-term charts to get a feel for how bullish/bearish corporate bond players are feeling. In other words: Is the bond/derivatives backdrop conducive to corporate bond buyers continuing to throw money at companies, which in turn can use it to defend and/or run up their stocks?

The place to start is the corporate bond market itself, and here we consider two questions. First: Is there good demand for new issuance and at what price? The first two charts show total corporate bond issuance and high-yield issuance since 2002. I have "crudely" annualized YTD data for 2012, even though the period from September to December tends to see more issuance than the other months. Regardless, all things being equal, 2012 should be a record year for issuance.

Source: Bloomberg LEAG Tables

Source: Bloomberg LEAG Tables

Positions in SPX
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