Monday, August 27, 2007

When Traders Shun Commercial Paper: A Historical Look

Recently, the gap in yields between 3 month Treasury bills and 3 month commercial paper widened significantly. This is because traders and investors were doubting the ability of corporations to meet their funding needs. The resulting run for the safety of T-bills depressed their yields, creating a gap last week of 1.92%.

To put that into perspective, I went back to 1980 (N = 1444 trading weeks) and found that this was the widest gap during that time. Indeed, the second widest gap was 1.43%, registered during the market panic in October, 1987. The median gap since 1980 has been 1.09%, as commercial paper has traditionally yielded a bit more than Treasury bills to compensate for an additional dollop of risk.

When commercial paper yields much more than Treasuries, however, the market is pricing in far more than a dollop of corporate risk. Since 1980, we have had only nine weekly periods in which commercial paper yields have exceeded those of T-bills by 30% or more. Here are the dates in descending order of yield spread:


You can see that these dates really only represent four periods in recent market history: Fall, 1982; late 1987; October, 1998; and the present period. The first three were excellent long-term buying opportunities. Fading fears of corporate liquidity turned out to be an excellent strategy. Let's see if the recent panic is similarly kind to the bulls.


Finding Gain Where There's Been Pain


Jimmy said...

doesn't the past take into account whether the 3 month bill spiked back up, like this past week?

Mike said...

Yeah, but how far % wise from all time highs were these buying opportunities? -5% -10% -20%?

This is going to get much worse before it gets better imo.

Brett Steenbarger, Ph.D. said...

Hi Jimmy,

Excellent idea; it would be interesting to look at returns after the yield spreads came back into line.


Brett Steenbarger, Ph.D. said...

Hi Mike,

It is not clear to me that panic after a relatively shallow decline is more bearish than panic after an extended one. One could even make the argument that panic after shallow declines *is* the wall of worry that bull markets climb.


jack said...

Would the findings be different if we extended the study to 1970?
1980-2000 happened to be a secular bull market. Most argue that it is over.

Brett Steenbarger, Ph.D. said...

Hi Jack,

Excellent idea for a study; thanks. I'm not convinced that the majority of investors or analysts see us in a post secular bull market mode.