Correction or Bear Market?

The S&P 500 is down 13 points, which seems small compared to recent days, but is a fair-sized move. Yet the 10-year is actually down 1/2 tick. During the 2000-2002 bear market, it was very rare that both the stock and Treasury market would move in the same direction.

Of course, one day doesn't mean a damn thing. Maybe the stock market will close tomorrow down another 3% and the 10-year will be at 4.35%. But right now there are a couple market moves that are pricing in a high probability of a true bear market.

• The CDX.IG index moved out 7bps over the last week. That's starting at 30bps and moving to 37, so its a fair-sized move.
• The CDX high-yield indices moved 30bps (BB) and 45bps (B) wider last week.
• Fed Funds Futures have rallied substantially. According to the Cleveland Fed's calculations, the odds of a cut in May is around 30%, and a cut by June is around 50% using futures trading prices.
• The slope of the Treasury curve has shifted dramatically. 2-10 slope was -13bps on 2/26. Now -2bps. This is notable because a steepening slope implies Fed cuts are coming soon.

Based on recent market moves, I think there are good opportunities in MBS and corporates. If you don't believe a recession is coming, but think the Fed may be willing to do 1-2 tweak cuts, then you believe interest rate vol will calm down from here. That's good for MBS. Buyers can just collect the nice big coupon without worrying about a big refi incentive. For both corps and MBS, the giant wall of liquidity isn't going anywhere. That will keep demand for quality spread product high. I think the brokers look particularly cheap now. They've widened out on jitters about sub-prime and high market volatility, but nothing happening today is fundamentally different than other problems Wall Street has faced in the past. I really think Lehman Brothers, Goldman Sachs, Merrill Lynch etc., have a reasonable handle on their risk and will manage though any period of high volatility.