Credit spreads and mean reversion - works well with trends

 

Credit spreads for both investment grade and high yield have been increasing with the decline in equity markets. These moves have been especially strong for junk bonds with low ratings. Investment grade have seen muted performance. High yield spreads are at the highest levels in five years if we extract the pandemic liquidity crisis of March 2020. The same can be said for investment grade. Trend-trading in credit is effective especially if it is conditional on the business cycle, equity prices, and financial stability. 

Within these long-term trends, there is also opportunities for mean-reversion strategies using a z-score methodology. If spreads widen by three standard deviations, there will be a spread tightening as new money tries to take advantage of higher spreads. The same can be said for the alternative of strong negative z-scores, however, this effect is weaker since it requires as selling of gains without a natural buyer. 

Investor who are buyers of extremes and hold for even a set time will be able to capture spread mean reversion. This mean reversion can be done in conjunction with trend trading to take advantage of macro and cross-asset changes as well as market extremes.