Using Bond Prices To Predict Future Stock Returns

Here is a link to an interesting article I discovered in Forbes over the Christmas holiday while sitting in the Philadelphia Airport.

The article in question discusses the investment strategy of former junk bond trader Peter Anderson. For a full synopsis, please read the article, but I will give the basic overview here. Basically, Anderson seeks to find a disconnect between how a company's stocks and bonds are trading, and looks to exploit the oversights of the "stock" guys, in favor of the research of the "bond" guys. As a company becomes less credit worthy, the price of their bonds decrease, and correspondingly, the cost of the debt (interest rate) that they have to pay to entice people to lend them money must increase. The inverse of this relationship is also true.

In theory, as a company becomes more financially sound, the price of their bonds should increase (they would also pay a lower interest rate), and their stock price would also be increasing. Anderson's theory, however, seeks to find bond prices which are performing well, and match them to company's whose stock prices are underperforming. Anderson believes that bond analysts are usually ahead of the curve in relation to their equities counterparts, and looks to exploit this fact.

I must say, I think this is an interesting theory. Furthermore, I think this is a good exercise to find stocks which are yet on the radar of mainstream media and stock analysts. When picking a stock, I never want to get in after somebody has published a headline listing the stock as a "buy". I want to already be in when I see those headlines, but that's just me. In researching after I read this article, however, there is no way to perform an easy screen of Anderson's criteria.