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In a volatile, unsteady market, it is difficult to pick out the stocks that will outperform others. One trick? Take a look at the company’s debt situation.
Strategists at Credit Suisse say that in uneasy environments such as this, equities that tend to do well are often those that sport tight credit spreads, reflecting investor perception that the debt in question poses lower risks than other corporations.
“Corporate bond spreads usually reflect the health or market sentiment of a company’s outstanding debt,” writes Pankaj Patel, analyst at Credit Suisse. “During a bear market, this becomes one of the primary concerns of the investor.”
The brokerage advises buying shares of these companies and shorting shares of companies with debt trading at spreads wider than the average corporation. This strategy does not work in all markets (riskier credits can outperform in periods when liquidity is rampant), but when lenders are restricting credit, it has worked, such as in 2002 and 2003, and since June of 2007.
Since that time, a basket of 20 companies constructed by Credit Suisse, which includes a number of defensive-oriented credits such as Coca-Cola Co., Wal-Mart Stores Inc., and health-care companies such as Eli Lilly & Co., were steady outperformers.
Meanwhile, companies that underperformed included a handful of financial stocks, including Washington Mutual Inc. and Iceland’s Kaupthing Bank. Overall, this long-short strategy produced a gain of nearly 15% since June 2007, while the Standard & Poor’s 500-stock index fell 9.6%.
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