The Credit indicator tracks credit/lending conditions which are often considered as a leading indicator of the equity market. Why? Because it is often the case that when lending dries up (credit/lending conditions are unfavorable), all the bad stuff happens. Or in Warren Buffet's words: "Only when the tide goes out do you discover who's been swimming naked."
Indeed, in unfavorable credit environments companies living on debt are unable to gain more financing and defaults or even bankruptcies happen, which in turn negatively impact the overall equity market and especially small caps.
Alquant bases its analysis on time series data on the returns of large high yield funds, such as the PIMCO High Yield Fund. Indeed, lower liquidity and lower volatility of the corporate bonds market generally force credit investors to take into account materiality considerations when reacting to new information. Thus, the credit market tends to react more instantaneously to material information, than the equity market. Meanwhile, information leading to more "normal" equity market movements is incorporated more gradually to the credit market.
Alquant processes time series data on returns of large high yield funds using a highly responsive algorithm designed to react quickly to a change in the high yield bonds market. If the analysis does not conclude that the short-term horizon is safe, cautious behaviour is recommended and exposure to equity is reduced. The algorithm is also tailored to return to maximum market exposure as soon as the environment returns to a favourable situation.
Alquant offers the result of its analysis in the form of an indicator ranging from 0% to 100% on a daily basis. The value of the Credit indicator is inversely proportional to the exposure to global equity markets that an investor should take in order to maximise his risk-adjusted return. For example, a value of 20% indicates that an 80% exposure to the underlying index is optimal in terms of risk and return.