For STOXX USA 500 companies that issue bonds, the first half of 2020 looked remarkably different that the second half of 2019 through the lens of credit spread changes.
- H1 2020: Almost every name saw its issuer spread widen from January through June. Due to the COVID crisis equity returns skewed negative, but there were still plenty of big winners like Apple and T-Mobile.
- H2 2019: Almost every name saw its issuer spread tighten from July through December. Equity returns skewed positive, but covered a range of gains and losses, with equity volatility relatively constant for most names.
- Theory 1: The market has repriced credit risk across the board, demanding higher spreads for all names, even those with high performing equity and lower default risk. The new regime has a higher market price of credit risk.
- Theory 2: There is a new regime in equity market volatility – 66% of the names in the index saw their June 2020 equity volatility more than double compared to their December 2019 volatility, and 31% more than tripled. In a Merton model framework, even massive equity returns may not be sufficient in light of the volatility increase to keep default risk from increasing and spreads widening.
- Charts: The pictures tell the story, plotting credit spread change vs equity return for the two periods. The color of the points indicates investment grade or high yield, while for the H1 2020 chart, the size of the points indicates the scale of the volatility change. Not surprisingly, airlines and cruise ships take the biggest hit across the board of equity, credit and volatility. But many equity winners also had significant volatility increases, consistent with credit spread widening. However, names like Netflix, with a 44% period equity return, no change in equity volatility, yet a 100 bp spread widening, suggest credit risk commands a higher premium in June than it did in January.