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Short Corporate Bonds About to Lose Investment-Grade Status

The economic collapse that has been triggered by the coronavirus has been swift and far-reaching. While there is the potential for a quick rebound in some segments of the economy, there will certainly be others that don’t fare so well.

The Federal Reserve and the federal government have stepped in to provide assistance, but this crisis is not going to pass without its corporate casualties. To prepare for this and to diversify our portfolio, we’re looking to utilize a popular corporate bond exchange-traded fund (ETF): iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD).

What Is LQD?

LQD, as its extraordinarily long name would suggest, invests in investment-grade corporate bonds. But what is an investment-grade corporate bond?

Any corporate bond issued by a company that has a rating of BBB or higher, according to the rating scales of Standard & Poors (S&P) and Fitch, qualifies as “investment-grade.” If you’re looking at the Moody’s rating scale, investment-grade corporate bonds are issued by companies with a rating of Baa or higher, but LQD focuses on the S&P rating.

Ratings agencies, like S&P, rate corporate bonds based on the perceived likelihood the company will default on its debts.

If the ratings agency believes there is a lower chance the company will default on its debt, it issues the company a higher, investment-grade rating on the company’s bonds.

If the ratings agency believes there is a higher chance the company will default, it issues a lower, non-investment-grade — or “junk” — rating on the company’s bonds.

As you can imagine, after the COVID-19 crisis, a lot of companies that used to have investment-grade ratings can no longer justify those ratings. The trick now is identifying which ones don’t.

Luckily, we don’t have to. We can simply trade LQD and let others do the work for us. You see, nearly half of LQD’s bond holdings are from companies with a BBB rating — the lowest investment-grade rating.

Breakdown of iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) Holdings — Chart Source: ishares.com

That means the value of a huge portion of LQD’s holdings will drop as we get more and more information about just how badly the economic downturn has hit American corporations and companies lose their investment-grade status.

Short Shares and Bearish Protection

We’re looking to short shares of this ETF as a way of protecting against further volatility. In the chart below, you can see LQD has gotten as low as $105 during the COVID-19 outbreak, and it is currently heading lower, albeit gradually.

Daily Chart of iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) — Chart Source: TradingView

Because the Federal Reserve has launched a number of new lending facilities and a new corporate bond purchasing program, we are not expecting LQD to plunge back down to its mid-March lows in the $105 range. We do, however, expect it to drop back down to its consolidation range just above support at $121 in the near term.

Shorting shares of the ETF could be a great way to collect a short-term profit while the market consolidates.

InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.

Article printed from InvestorPlace Media, https://investorplace.com/2020/05/short-corporate-bonds-about-to-lose-investment-grade-status/.

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