Last week, Jeffrey Rosenberg at Bank of America wrote that he thought lower-rated corporate bonds and equity markets were in for a rough few weeks ahead:
Recovery means recapitalizing the banking system and weaning our corporate and consumer segments from a culture of debt and leverage. For corporates this phase means re-equitization - issuing equity to meet near-term funding requirements that debt markets are incapable or unwilling to provide while at the same time strengthening capital and reducing future default risks.
We wrote that the most recent round of “stabilisation” measures aimed at the world’s banks and credit markets were in that light, merely passing the buck.
Throughout the crisis, credit markets have led equity. And it’s for that reason that the latest round of equity rallies look like a short-term uptick in an otherwise downward moving market.
Falling Libor and resurgent money market funds do not a credit crisis undo. In the credit market at large, fear is increasing, not abating.
Mish Shedlock points to an “armageddon in corporate bonds”, and publishes this chart from Moody’s:
The question is whether the latest sell off to roil the corporate bond market has much to do with fundamentals. Bloomberg, in an article we highlighted on Monday, reported that fixed income markets were now providing a “once in a lifetime opportunity” to buy.
And yet, the outlook for fundamentals is not good. Mish reports that current prices impluy a 5.6 per cent default rate. All the major indications are that defaults will increase beyond that. Historically speaking, we’re still nowhere near an expected peak:
And indeed, the panic about a surge in defaults is being born out right now on the usually prescient CDS market. The iTraxx Crossover index of junk-linked CDS is at an all time wide, and the LevX index of swaps on leveraged loans is collapsing. This from Monday’s CDS report:
At 1130 GMT [the iTraxx Crossover] posted a new wide of 783 basis points according to one trader. Markit had a closing level of 760.4bp Friday amd 779bp at 1133 GMT…
The LevX index of credit default swaps on risky loans was two points lower at 83 - implying the market believed that 70 per cent of the constituents of the index would default on their secured loans, said the trader.
The global outlook is not good. Economists are predicting a severe global recession. In a Deutsche Bank note on Monday, Joel Crane wrote of the economic outlook:
…we now expect a major recession for the world economy over the year ahead, with growth in the industrial countries falling to its lowest level since the Great Depression and global growth falling to 1.2%, its lowest level since the severe downturn of the early 1980s. We also see a steep drop in global inflation to 3.1% next year thanks to a collapse of energy prices and rising unemployment.
Quite something to wake up to. As for a recovery - a bottom - the Deutsche analysts don’t see stabilisation occuring until 2010. A recovery won’t occur until further beyond that: “unlikely in the foreseeable future”.
All that and yet equities are rallying. The FTSE 100 was up again this morning. More to the point, it’s up 9.21 per cent since October 13: A period over which the DJIA and Nikkei have likewise rebounded: up 9.63 per cent and 12.44 per cent respectively.
We’d again stress the point: this is a credit crisis, and equity is the first loss tranche.
