What is Barron's Confidence Index?
Barron's Confidence Index measures investor confidence by comparing the respective average yields of high-quality bonds to lower quality bonds.
- Barron's Confidence Index measures investor confidence by comparing the respective average yields of high-quality bonds to lower quality bonds.
- Barron’s Confidence Index is rooted in the notion that bond traders are more sophisticated than stock investors and that, as a result, their actions are more predictive of future market activity.
- Barron's Confidence Index = (average yield on 10 top-grade bonds ÷ average yield on 10 intermediate-grade bonds) x 100.
Understanding Barron's Confidence Index
The Barron's Confidence Index is a ratio that can be useful in deciphering investors' desire to assume additional risk when entering into an investment decision. The comparison is between the average yield-to-maturity (YTM) of Barron's best-grade bonds to average yield-to-maturity of intermediate-grade bonds.
To arrive at the value, Barron's divides the average YTM of its 10 best-grade bond list by the average YTM of 10 intermediate-grade bonds and then multiplies this result by 100. The index, with a theoretical maximum value of 1, is published weekly and is seen as a proxy of investor confidence in the U.S. economy. It is also referred to by the Weekly Barron's C.I./Yield Gap.
Barron's Confidence Index = (average yield on 10 top-grade bonds ÷ average yield on 10 intermediate-grade bonds) x 100
Barron's Confidence Index is rooted in the notion that bond traders are more sophisticated than stock investors and that, as a result, their actions are more predictive of future market activity. Since bond prices and yields are inversely related, the theory posits that optimistic investors are more likely to invest in riskier, lower-quality bonds, thereby driving the yields of these bonds lower. The safer, high-quality bond yields would remain stagnant, or possibly rise as investors might either not buy them, or sell them and use the funds to buy the riskier investments. This would cause the Barron's Confidence index to move higher.
From a mathematical perspective, the Barron's Confidence Index should always be less than, or equal to, 100 percent given that yields on top-grade bonds are always lower than yields on lesser-grade bonds. For example, if the average yield of high-grade bonds is 2.5 percent and the average yield of the intermediate-grade bonds is 3 percent, the Barron's Confidence Index is 83.33 percent (2.5 percent divided by 3 percent and multiplied by 100).
When investors are confident about the economy's future, they are willing to take more risk and buy more speculative bonds. The price of higher-quality bonds then goes down, which increases their yield. This dynamic indicates investors need lower premiums in returns to take on increased risk. An index around 80 percent is considered a bearish outlook for the stock market. When confidence in the economy is low, investors seek higher quality debt, which increases bond prices and lowers yields.
While the raw index number is meaningful, it's also useful to track its direction. A falling confidence number indicates decreasing confidence in the market. A rising value, of course, means increasing confidence.
Background of Barron’s Confidence Index
Barron's is published by Dow Jones, which is owned by News Corporation. It covers financial information, market developments, and relevant statistics and is published online and in print weekly.
Barron's best-grade bond list comprises 10 top high-grade bonds, typically AAA rated, which is the highest possible rating assigned to an issuer's bonds by credit rating agencies. AAA-rated bonds are highly creditworthy because the issuer can easily meet its financial commitments. The intermediate-grade bond list includes ten lower-grade BBB rated bonds, which are so designated because there is a higher risk that the issuer will default on the debt.