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Here’s another example of partners investing in each other’s success. I know of a company that paid to have consultants teach strategic planning to their employees’ union.Many members of management were dumbfounded when they heard about this. They wondered why the company would pay to have the union become more organized and stronger through company-provided strategic planning. When the question was asked of the CEO, her answer demonstrated her high PQ: “In the next round of negotiations with the union, I want them to know what their members want so we can get down to the critical issues that are facing our industry. Neither side wants to drag out these talks. It’s an investment in our management’s time to have the union be strategically prepared for these negotiations.”

The refinancing sensitivity increases with a decreasing credit quality. This means that weak B- and C-rated companies are the most refinancing sensitive. There is a close relationship between the ratings cycle and the Fed fund cycle. Atight Fed policy goes hand in hand with a lower amount outstanding of CCC paper. If the Fed switches to an easing mode the proportion of CCC-rated bonds will increase in the credit market. AFed tightening policy goes along with credit rating upgrades whereas an easing policy cycle is usually associated with credit rating downgrades. This is because the effects of the Fed policy will have an impact on the credit markets with a time lag of several months.

Asteepening of the treasury curve – driven by declining short-term rates will provide the credit market with liquidity, which in turn helps to lower default rates. In this scenario, companies will have easier access to liquidity (e.g. bank loans, debt and equity markets).

Overall, the analysis suggests that credit spreads are highly correlated with the business cycle and that there is a leverage cycle that is closely related to macroeconomic activity variables. While carry-driven strategies may work most of the time, a thorough understanding of the leverage cycle helps to anticipate a harsh credit environment, even before it is reflected in GDP growth and equity performance. As the years 1997–2000 have shown, information from the equity markets is clearly not sufficient as an indicator of business and financial risks in the corporate sector. Most companies go through a regular cycle of leveraging and deleveraging, which is related to the profit and Capex cycle. Especially trends in mergers and acquisitions have a significant impact on the performance of credit markets.

Consequently, the concept of “safe” and “risky” companies loses its allure. Companies from sectors like utilities or noncyclical services that are considered safe today may increase leverage and be more risky tomorrow. On the other hand, highly leveraged companies may decide to deleverage and thus lower their business risk, like the European telecom sector in 2002 and 2003. Although the profit cycle is more pronounced in cyclical sectors, a credit cycle may be observed across virtually all industries. Credit markets react to this dynamic process through spread tightening and spread widening, thus causing investors mark-to-market profits or losses.