Wednesday, January 09, 2008

I felt it too

First let me say that I'm not surprised the market rallied strong today. Like I said yesterday, we knew Countrywide was in serious trouble. We've known this for months. Why does the market sell off 200 points on news that was widely expected? With the market taking about 2/3 of it back today, I'd say that sell-off was mostly fast money driven.

That doesn't mean we won't keep going lower. As I discussed the other day, it sure seems like the corporate bond market is set up for a much worse economic outcome than the stock market. Corporate bond spreads are as wide or wider than the last 2 recessions, and yet the stock market valuations seem sanguine on the topic.

But there are some good arguments for the diversion. First of all, the corporate bond universe and the stock market universe are not the same data set. Here are the top 10 investment-grade bond issuers:

General Electric
Goldman Sachs
Bank of America
Morgan Stanley
JP Morgan
Merrill Lynch

Here is the top 10 for the S&P 500
Exxon Mobil
General Electric
Procter & Gamble
Johnson & Johnson
Bank of America

Within the S&P 500, only GE, AT&T, and Bank of America would appear on both lists. And interestingly, among the top 10 corporate list, only AT&T's stock is closer to its 52 week high than its 52 week low.

So perhaps the divergence in corporate/stock valuations isn't so strange after all. Perhaps the kinds of companies who are large bond issuers are struggling in the stock market as well. Perhaps the kinds of companies which are keeping the stock averages afloat are not big bond issuers: XOM, MSFT, PG, etc.

We may be looking at a sort of weird recession coming up. One where layoffs aren't as bad as some past recessions, but consumer spending drops substantially anyway, because of credit availability. I could see such a recession not being terribly bad for stocks. But financials are right on the forefront of these problems. If that's how it plays out, then the financial-laden corporate bond indices will at best stay wide for a while, even if the stock market improves.


Anonymous said...

"Corporate bond spreads are as wide or wider than the last 2 recessions"[AI]
Thanks, that is very helpful and the data are not readily accessible to me.

flow5 said...

The FED hit the panic button. $6b in 1 day repos, $9b in 7 day repos, & $9b in 14 day repos. It is now officially pursuing an "easy" or less restrictive monetary policy.

As before: Stocks rise when the rate-of-change in the money supply exceeds or increases versus the rate-of-change in inflation. The other requirement is that money & credit growth are not so excessive that prices rise above the FOMC’s inflation target. The concept is dubbed “real-money” and it’s supposed to follow real-gdp.

Currently most private economists are forecasting slower economic growth. And under Bernanke’s leadership, the FOMC’s forecasts have been reasonably accurate. So the conclusion would be that any “easing” by the Fed (to counter recessionary tendencies)would translate into higher stock prices, ceteris paribus.

That's the impetus behind the last 2 days rally.

Anonymous said...

hi, in comparing spreads re: last recessions, which index do you use?


Accrued Interest said...

I was using the Lehman Credit OAS, which is LUCROAS on Bloomberg.

Anonymous said...

Bernanke's seminal (you should excuse the expression) article on the Great Depression, which is definitely worth a read and which I will try to find the URL for, states clearly that the Depression occurred because central banks kept money tight too long.

It's kind of like jibing and holding on to the mainsheet for all you're worth...the darn boat tips over.

He also points out that the Depression was far worse in France, for example, where money was kept tighter longer.

Well, history seems to be repeating itself. The ECB, in the face of whatever is happening in the world, is keeping money tight. Yes, they are pumping money in targeted ways, but the big rate is steady.

Does that mean we should all invest in euros and buy the first born of desperate Europeans when things turn really sour.

Oh, and by the way, the market's down today.