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Bond Market-Aggregate Earnings Interactions

Posted in Bonds, Fundamental Valuation

Do aggregate corporate earnings predict bond market returns? In his January 2012 paper entitled “Aggregate Earnings and Corporate Bond Markets”, Xanthi Gkougkousi investigates the relationship between aggregate earnings and corporate bond market returns. Using quarterly aggregate earnings for a broad sample of U.S. stocks with fiscal years ending in March, June, September and December and total quarterly returns for ten U.S. corporate bond indexes during January 1973 through December 2010 (360,614 firm-quarter observations), he finds that:

  • Average quarterly returns of the various corporate bond indexes range from 1.9% to 2.3% over the sample period.
  • Aggregate earnings changes relate negatively to contemporaneous investment-grade corporate bond index returns and positively (but insignificantly) to high-yield corporate bond index returns. Compared to prior research, results are largely:
    • Opposite a firm-level positive relationship between earnings changes and corporate bond returns.
    • In accord with a negative relationship between aggregate earnings changes and stock market returns.
  • The aggregate earnings-returns relationship is weaker for bonds with higher credit ratings and longer maturities.
  • While aggregate cash flows relate negatively to corporate bond market returns, aggregate accruals have little explanatory power.
  • The relationship between aggregate earnings changes and bond index returns is strictly contemporaneous, not predictive. In other words, using aggregate earnings to predict corporate bond market returns requires an accurate forecast of aggregate earnings.

In summary, evidence indicates that there is a significantly negative, but strictly contemporaneous, relationship between aggregate corporate earnings and corporate bond market returns.

Cautions regarding findings include:

  • Returns are gross, assuming frictionless construction of tradable assets from bond index components.
  • As noted in the paper, the strength and even direction of the relationship between aggregate earnings and corporate bonds varies with bond quality and maturity.
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