Today in the United States, a company using its workforce as Ford did would find it tough to stay afloat. Such labor-intensive processes would be too expensive. And besides, people are generally more educated today and want work that’s more meaningful.What robots can’t do is the creative, team-oriented work that requires sophisticated communication and decision making. Managing creative teams is different from managing mechanical processes. Consequently, when the way the workforce operates begins to change, management’s thinking also needs to change. In many organizations, however, workers are constantly asked to change and upgrade their skills—only to be led by people using the same style of management that was in vogue fifty years ago.

Management’s job today is to build partnerships within organizations. In an information-based economy, no single group can be the sole purveyor of the “raw material” needed to manufacture the product. In fact, after decades of diversification, many businesses are actively reverting to their core business competencies and outsourcing those portions of their business that are not designed to satisfy their customers needs.

The addition of the individual contributions to expected excess return in Our study yields an expected 1-year excess return of 88.2 bp for A-rated corporate bonds with a maturity of 5-years. This is significantly below the initial spread of 100 bps. The difference reflects the fact that a downgrade is more probable for A-rated corporate bonds than an upgrade, and that the associated spread changes are not symmetric. The magnitude of spread widenings due to downgrades is usually much higher than the spread tightening after rating upgrades. It is interesting to note that among investment grade bonds the ratio of upgrades to downgrades is most favorable for Baa-rated bonds. However, in the case of a downgrade these bonds often suffer massive price declines, because they fall below investment grade levels.

The following paragraph will deal with default rates because they are of central importance for high-yield investors. We compare the three major default peaks since 1920. Default rates have to be distinguished between “issuer-weighted” and “dollar-weighted”. The increasing amount of Fallen Angels in 2002 resulted in a sharp increase of the “dollar-weighted” default rate.

High-yield spreads tend to lead default rates, which means that a tightening will occur prior to a fall in the default rate because market participants will already anticipate the future development of the default rate. This relationship broke down in 2002 for a couple of months due to the large divergence of the “dollar-weighted” from the “issuer-weighted” default rate. As we can see cumulative default rates tend to increase progressively with a decreasing rating class.

Interestingly, the relationship between equity and bond markets differs in deflation-risk periods and inflation-risk periods. In inflation-risk periods, rising inflation rates push up long-term interest rates, reflecting the fear that aggressive monetary tightening will depress future earnings and hence stock prices. Thus, in periods of rising inflation risk, government bond prices and stock prices tend to fall. In deflation-risk periods government bond prices and stock prices usually go in opposite directions, because fixed income markets benefit from the expectation of falling interest rates, while equities suffer from the worsening profit outlook and increasing default risk. Credit spreads tend to benefit from rising inflation because it becomes easier for companies to pay down their debt.

Deflationary periods usually lead to a spread widening across the whole credit market, hitting consumer-related industries the hardest. However, long-term interest rates seem to have a minor influence on fluctuations of credit spreads in the short term. Companies that borrow at a fixed rate are immune to changes in yields and spreads over the life of the borrowing. Yet, there is a refinancing risk, when debt has to be rolled over. Conversely, when companies borrow at floating rates, they are directly affected by changes in money market rates, which are primarily driven by monetary policy.

While liquidity risk is primarily a function of the willingness and ability of banks and brokers to provide liquidity and of investors’ readiness to take on risk, in other words, risk appetite, the other two points are related to the economic environment. The companies’ ability to generate sufficient cash flows to service their liabilities is central for the probability of default and is reflected in ratings. In general slowing economic growth, usually coupled with lower private consumption due to weak growth of labor income and rising unemployment undermines the profitability of the corporate sector.

In this context, it is worth remembering the definition of a recession. Market participants often define recessions in terms of two consecutive quarters of decline in real GDP. The National Bureau of Economic Research (NBER) which is responsible for dating recession periods, however, claims that recessions are characterized by a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale–retail sales.

Numerous empirical studies confirm that the economic cycle is an important determinant for the performance of credit and government bond markets. They find that credit spreads are negatively correlated with GDP growth.. Historically, spreads tightened during the early stages of economic expansions, and spreads widened during economic recessions. Crabbe and Fabozzi (2002) note that during the ten economic cycles since the end of the Second World War, the Baa–Aaa quality spread typically already widened in the months leading up to a recession. After a recession began, spreads usually continued to widen, peaking approximately 10–14 months into the cycle. The magnitude of the spread widening as well as the duration of the spread widening, however, varies from cycle to cycle, depending primarily on the duration of the recession period and the magnitude of the economic downturn. The fact that credit spreads tend to widen before the business cycle peaks indicates that corporate bond investors often anticipate future economic developments.

Focusing on macroeconomic activity variables, therefore, is not sufficient to predict changes in corporate bond spreads. Investors should carefully analyze leading economic indicators as well as any evidence that corporate profitability slows or leverage increases. Both factors result in a reduced ability to generate cash flows and weakens credit quality, resulting in a higher risk of default.