C.M.O. 2.1.2010
Credit Market Overview
February 1, 2010
Sinking sovereigns, Obama’s bank bashing and a bruising Bernanke confirmation combined to offer no relief to a market attempting to get up off the canvas. The 1.64% loss for the SPX last week added to the 5.08% drop from the high set on January 19th puts the S&P 76.36 points away from continued upward progress. Ironically 185 stocks made new highs on the NYSE while just 22 made new lows last week.
With some companies raising forecasts and many adding to the top as well as bottom line during the current earnings season it would appear investors prefer bad news to good. This method of interpretation applied to more than just stocks last week as the much anticipated sale of Greece’s 5-year bonds last Monday was initially considered a success after E25BN of bids came for the E8BN of issuance, albeit at a yield of 6.2%. That all changed within 24 hours as the yield rise to 6.35% after no substance was found to an article in the FT that the Greek government had retained Goldman Sachs to arrange a separate sale to China.
The fiscal stimulus used by many of the leaders of the world’s developed economies has created a rare anomaly in the debt markets as there are now cases where the debt of some of the larger corporations in a given country are trading at less of a yield premium than the government paper of the same nation.
This is counter-intuitive to the extent that, “companies within a country can’t be better credits than a country itself because they have the power of taxation. They can always use that to prevent a default”, said Jim Bianco of Bianco Research in Chicago. “It’s kind of an irrationally priced market”, he added.
The anomaly is not only in Athens; it costs 105bps to buy default insurance on 5-year bonds issued by Banco Santander SA, the largest bank in Spain while costing an investor seeking default protection on Spain itself 120bps.
If you’re thinking that this is a problem for just the PIIGS, I would ask you to think again as default protection for Uncle Sam’s I.O.U’s cost 45bps on Friday while there were over 70 corporate issuers trading with a lower probability of default.
Market anomalies, when they do exist, are usually arbitraged back into line fairly quickly but that might not be the case this time as it seems the size of each week’s auction by the U.S. Treasury has the word “record” in the headline of the article describing the particulars. This should be compared with what Barclays Capital thinks could be a 30% smaller issuance calendar by U.S. corporates and 25% less for Europe. There is nothing more basic in the markets than the law of supply and demand.
What effect is all of this having on investors? According to Barclays Capital the worse off you are the longer the line to buy your debt. “Venezuela’s foreign exchange reforms/devaluation, Argentina’s central bank affair, Ukraine’s elections or Turkey’s IMF prospects, promise to generate the greatest sources of returns”, was how they put it in a recent research report.
The king of the bond market, or at least the co-CIO at PIMCO, isn’t one of those standing in line but he’s not a fan of Treasuries either given the lack of fiscal restraint by the current Administration. Bill Gross is traveling to Europe. Well, he’s not but his money is and more specifically to Germany. Bill thinks the more responsible way in which the stimulus spending was handled in Fatherland will prevent the need for runaway issuance and a more fiscally sound economy. It’s part of what he and the other folks at PIMCO are calling the “new normal”.
Given all that has transpired since July of 2007 it would appear that the new normal is that things are abnormal.
Enjoy the weekend.
Jim Delaney
