How Bond Markets Can Predict Moves in Stocks
The “smart” money may deserve its reputation after all.
Liquid, high-yield bonds foretell equity moves: Berkeley study
Professor says shares react more slowly to complex financials
High-yield bonds moving with the ebbs and flows of U.S. earnings announcements tend to predict stock returns for a slew of issuers -- particularly firms with a modest level of institutional equity ownership. So stock investors seeking an informational edge should keep their eyes on junk-bond prices on the heels of earnings reports....MORE
That’s the conclusion of a paper by Omri Even-Tov of the University of California at Berkeley, who took a look at the bond returns that followed a whopping 19,518 quarterly earnings announcements of 770 firms from 2005 to 2014.
“The bond price reaction provides incremental explanatory power for post-announcement stock returns over and above the information contained in the earnings surprise (the post-earnings announcement drift), the level of reported accruals (the accruals anomaly), and the immediate stock price reaction to the earnings announcement,” writes Even-Tov, an assistant professor at the Haas School of Business.
“This suggests that the sophistication of bond traders relative to stock traders is a driver of the ability of bond returns to predict post-announcement stock returns,” according to the paper, published this month in the Journal of Accounting and Economics.
Even-Tov is wading into three of the most contentious debates in finance: the efficiency of the credit market relative to its stock-market peer; the ability of active managers to exploit mispricing in asset classes; and whether the credit cycle’s tendency to presage turning points in equities and the economy stems from all the “smart” money invested in bonds.
The author calculates a given firm’s bond price reaction to earnings from the value-weighted average of its individual bond returns and finds a positive correlation with buy-and-hold stock returns 60 days after an earnings announcement, above what could be expected from the immediate earnings surprise.
In other words, when a company’s bond price moves in the aftermath of an earnings beat, for example, its share price will eventually follow suit as stock investors belatedly decipher the complex financial statements.
Of course if ya snooze ya lose.
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