Last year, in my ExcelUser blog, I introduced this index of investor confidence. As this figure shows, the index continues to head south.
Here's how it works:
If investors are optimistic about the future, they’re more likely to invest in high-interest bonds issued by lower-quality, higher-risk companies.
On the other hand, if they’re pessimistic about the future, they forgo the higher interest rates of those higher-risk companies (rated BBB or CCC) and instead invest in lower-yield, but lower-risk companies (rated AAA).
Therefore, the relative prices of the AAA, BBB, and CCC bonds provide an accurate measure of how confident investors are about the future of the economy.
This version of the index divides AAA yields by BBB yields.
The thick blue line shows the actual value. The thin black line smooths the trend. And the shaded area shows the recent recession.
Unlike surveys of whimsical public confidence, this index measures the informed opinions of investors who have placed significant bets on their opinions about the future. The average of those opinions has been somewhat prescient in the recent past. Specifically, notice that the index stopped rising two years before the recession, and fell sharply nearly a year before it began.
So it's a concern that this index continues to fall.