The junk bond market has attracted a lot of attention lately, as spreads have blown out.
Also referred to as high-yield bonds, these debt securities are issued by companies with low credit quality. Because of the higher risks that come with lending to such companies, they have to offer higher yields than those of their investment-grade peers. When spreads increase, it’s costing more for these junk corporates to borrow.
But what’s that mean for the stock market?
That’s a complicated question, but we can begin answering by figuring out how much of the S&P 500 consists of junk-rated companies. After all, these are the companies that could run into problems obtaining financing should they need it.
“Of the companies in the S&P 500, only 57 (11%) are considered non- investment grade (Figure 10),” Barclays’ Jonathan Glionna observed.
“Furthermore, the companies that are high yield tend to be small. When adjusted for market capitalisation, the percentage of non-investment grade companies drops to just 4% (Figure 11),” he added. “Overall, 91% of the market capitalisation of the S&P 500 is attributable to investment grade rated companies.”
“Another 5% belongs to non-rated companies that typically have no debt,” Glionna added. “These are often fast growing technology or biotechnology companies that are entirely funded with equity capital.
“So, a widening of high yield spreads is only going to matter for a limited number of modestly-sized companies in the S&P 500.”
Now, if spreads are blowing out because of a recession or financial crisis, that’s a whole other matter …
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