C.M.O. 2.27.2009

Credit Market Overview
February 27 2009

I have offered in this space recently historical evidence of how fiscal stimulus is not the right prescription to bring the economy out of its current malaise by quoting FDR’s Treasury Secretary, Henry Morgenthau’s dairy entries including: “We have tried spending money. We are spending more than we have ever spent before and it does not work.” which rings so true in the face of the recent +/-$800BN spending bill just signed into law.

Additionally, I have also discussed the work of Friedrich Hayek a contemporary of John Maynard Keynes but an opponent of Keynes’ thinking “that general employment was always positively correlated with the aggregate demand for consumer goods."

As these do not seem to have made an impact I bring another more contemporary example; that of the great growth engine of the world at the moment, China. The government of the People’s Republic has put about 230BN Yuan ($34BN) into stimulus projects in that country recently. Immediately following the announcement of this package steel prices began to rise and bank lending increased. Affects the current administration is hoping will repeat themselves in the U.S.

The problem is that those affects are now proving to be superficial and do not appear to have restarted China’s real economy. Steel prices, which had gained 15% from the November lows to the beginning of February are now falling again, industrial output in Shanghai was down 12.7% in January from the same period last year and the 1.62TN in new loans made, twice the 2008 number, are being hoarded by those companies that borrowed the money so the usual expansive effect of “borrowing to build” is non-existent.

“Recent monetary and credit data do not reflect real economic demand.”;Ha Jiming, chief economist of China International Capital Corp. You see, even they realize it’s not working.

I quoted Robert Rodriguez, CEO of First Pacific Advisors, yesterday as recently saying that his investment mantra was: “Winning by not losing.” Proof of how RR’s words ring true in the current market place and especially for the CEC Strategy can be found by looking at the CDS/equity relationship of names in the healthcare field.

CVH is the most dramatic example as CDS spreads have recently come in from their highs around 570bps to the 475 level, a 95bp or 16.67% contraction. Moves lower in CDS spreads, ceteris paribus, usually portent higher stock prices but the just announced plan to pay for the health care plan by taxing the healthcare providers has thrown a “spanner in the works” as the stock has plummeted from the $16.87 recently to $11.88 yesterday. That’s $4.99 or 29.58% for all of you that had a “Thirsty Thursday” last night.

When the markets move as they have been and policy announcements change the economic landscape overnight, Mr. Rodriguez’s mantra seems to be a good one to keep in mind.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.26.2009

Credit Market Overview
February 26 2009

Robert Rodriguez, CEO of First Pacific Advisors, stated during a Barron’s interview recently that his investment mantra was: “Winning by not losing.” True to his word RR had up to 45% of his main fund in cash at certain points last year.

Although the VIX is down from its 52.62 close on 2/23/2009 that might be reflecting non-participation as much as a reduction in fear. Since 2/10/2009 there have been only 2 days with less than a 2% range from the previous night’s close on the SPX. The average daily range for this period has been 3.3% with a max of 5.2% on the 10th. While there might not be fear it would appear uncertainty abounds.

One of the things people do feel pretty certain about is that it will take a bottom in housing and the financials for any turn higher in the market to be more than an oversold technical rally.

Tuesday’s release of the Case/Schiller home price data showed prices 27% from their 2006 highs and inventory levels at 9.3 months of overhang vs. 11.2 months in November. While these numbers might seem encouraging Michelle Meyers, an economist at Barclays warns that the inventory numbers are not seasonally adjusted so they could rise again come spring.

The other two caveats she mentions are that a good portion of the recent purchases were by speculators who will not hesitate to dump their properties back on the market if the downturn persists. Additionally, while the current roughly 9 months of unsold home supply is better than the 11 number from November it is still twice the “normal” level of about 5 months. Michelle does not feel housing prices will bottom until a peak to trough number of about 40% is reached.

One can only imagine what the additional 13% drop in home prices will do to foreclosures and their ripple will affect on all things credit and confidence related.

An interesting piece in the WSJ Op/Ed section yesterday discussed how earnings were calculated for the S&P and how it differed from how the index itself was calculated. The index, as we all know is capitalization weighted so that a 1% move in XOM affects the index more than a 1% move in JNY.

The earnings it seems are not weighted in the same proportion so that if XOM makes a buck and JNY loses one S&P earnings are said to be zero. Using this methodology people are coming up with earnings numbers in the $40-$50 range and saying that the current SPX levels are too high as a result. The Op/Ed piece argues that earnings should be weighted in the same proportion as the stocks themselves. In doing this the author calculates that earning on the S&P are probably closer to $70.

I have never constructed or arbitraged indexes but the logic of the argument does seem to make some sense if only for reasons of consistency. As with all things, however, the market looks at what the market looks at and as we have all learned, the market is ultimately always right.

Enjoy the week.

Jim Delaney

C.M.O. 2.25.2009

Credit Market Overview
February 25 2009

It was good to have things back to normal yesterday. Consumer Confidence, projected at a lofty 35 came in just 10 points below at 25; S&P cut Latvia’s credit rating to BB+ putting it in “Junk” land and the S&P saw all of the good news in those events and rallied 29.81 points.

CDS spreads which have been following the stock market as of late vs. made a move as well with the High-Yield index closing at 1477.2 in New York down 68.7bps or 4.44% from Monday night’s close which was through the February 5th close of 1494.4, it’s most recent high.

Investment grade spreads turned down as well but not nearly as dramatically as those on the other side of the investability tracks. At 215.5bps IG spreads are still above the “200” line but in this latest sprint they did not get above the 222.1 level seen on the 23rd of December last year.

Looking at a chart of the levels one could almost make the case for lower highs which the technicians out there know is at least half of the equation for a down trend. The other half is lower lows but we will have to get through 187.6bps, which occurred on February 9th for the second piece of the puzzle to fall into place.

It has been a rare occurrence as of late to have the markets respond positively when the cameras are pointed at anything in D.C. but the first day of Ben Bernanke’s semi-annual testimony in front of the Committee on Banking, Housing and Urban Affairs seems to have broken that trend as well. Chairman Dodd was down right obsequious when addressing the Chairman of the Federal Reserve and others on the panel acted as if they were wearing those white gloves workers in museums don when handling a work of fine art.

Sen. Bob Corker (R. Tenn) was the only one in attendance that was having a hard time understanding, in his dumb like a fox sort of way, how stress testing the banks and then giving them whatever they needed to pass the test was not ipso facto “Nationalization”.

Ben kept his cool and explained that to the extent there was still a stock price to be quoted, something which can’t be said for a handful of other institutions that were around this time last year, then the bank in question had not been nationalized.

I do find it amazing how smart you have to be to say really dumb things.

Enjoy the week.

Jim Delaney

C.M.O. 2.24.2009

Credit Market Overview
February 24 2009

I read somewhere recently that people in government don’t spend much, if any, time gathering information from the media as the information they do process comes from more selective sources through established channels. I can only interpret that to mean that they get rid of those that don’t agree with their theories and then listen to the one’s left; but then watching the markets since the politicians took over the financial reigns can make you pretty cynical.

The real shame in all of this is that there are some pretty heavy weight characters being published in the op/ed columns these days and while they are out to make a point in many cases the arguments they proffer are cogent and concise.

This past weekend no less than Dr. Doom himself, Nouriel Roubini and Willem H. Buite were in print. The former is a household name at this point if from nowhere else but reading this piece. The latter, WHB, is a professor of European political economy at the London School of Economics and Political Science so there is some gravitas there as well.

Mr. Roubini is pushing a ‘90’s Swedish encore. “You take the banks over, you clean them up, and you sell them in rapid order to the private sector--it’s clear that it’s temporary. No one’s in favor of a permanent government takeover of the financial system. (Can someone tell Sen. Frank that please?)

Professor Buiter’s approach is slightly different in that he would prefer to create brand new institutions with the $1.4BN that is being bandied about as the amount of tax payer money it would take to restore the U.S. banking sector to its fall 2008 level.

The advantages here would be brand new management, with a new focus in a growth oriented environment. Since these new banks would be fresh ventures with no warehouse of toxic assets the possibility of attracting private capital would also be much greater than asking the capitalists to put their dead Presidents into a bank where the probability of losing most if not all of their investment is exceedingly high at the moment.

The “legacy banks” as Mr. Buiter calls them would not be allowed to make any new investments or loans and would simply manage the dross on their books. If things don’t go well Willem says, the secured creditors would be there to fight over the remains.

The market on Friday fell on news that some banks might be nationalized. It fell yesterday because nationalization was thrown out as an option although after contributing $45BN of taxpayer money already, the possibility of the government owning up to 40% and a $2 stock price if Citi isn’t nationalized I’m not sure what else to call it.

Being a “free-market” advocate I get what Nouriel and Willem are saying. Given how many of our Treasury bonds foreigners hold and are expected to buy in the near future I’m not so sure telling them that the common and preferred stock they were nice enough to buy from some of our premier financial institutions is now worth zero and we don’t care.

Enjoy the week.

Jim Delaney

C.M.O. 2.23.2009

Credit Market Overview
February 23 2009

For anyone who is not a Citibank customer it is now cheaper to buy the stock than get cash through one of their ATM’s. Citigroup (C) closed at $1.95 on Friday, the non-customer access charge for cash is $3.00. For you history buffs the last time C was at these levels was 1991. Similarly, at $4.07 a share of stock in The New York Times Company (NYT) is just 7 cents more expensive than its Sunday “bulldog”.

Returning to the banking sector for a moment, while C priced at $1.95, BAC at $3.79 (24-year low) and WFC at $10.91 might appear cheap the same cannot be said about default protection on these entities’ bonds.

CDS levels on Citigroup have increased by 77% in the last 10 trading days closing on Friday at 465bps. BAC has seen a 62.5% increase in its 5 year benchmark CDS contract in the same period and Friday’s 273bps was also an all-time high for the name. Last but obviously not least WFC’s CDS’s have gone up 94.4% in just 8 trading sessions.

The Government was all over the media on Thursday and Friday saying that nationalization was not the preferred option and our erudite Fed Chairman himself has said: “it is challenging for the government to manage banks over long periods of time.” While that might be true who says it has to be a long period of time and possibly more important, what is the Fed going to do when the market pushes the stock prices of these three institutions and some of the other banks to zero?

The markets as a whole seems less than impressed with the verbiage coming out of Washington and one jokester quipped “The last thing that came out of Washington that most of the public was happy to see was the helicopter carrying President Bush to Texas on January 20th!

Craig Peckham, equity strategist for Jeffries says “It’s impossibly hard to call a bottom for bank stocks. With the inability of the marketplace to pinpoint any base value for banks; the loss story and capital erosion picture continue to drive shorts.”

Echoing Craig’s sentiment, Dave Henderson with Dru Stock Inc, described Friday’s saying “Everyone is selling first and asking questions later. I don’t know where the bottom is but we’re one day closer to it.”

With more than 8BN shares changing hands it would appear that those who look to volume for validation are getting the message loud and clear.

Enjoy the week.

Jim Delaney

C.M.O. 2.20.2009

Credit Market Overview
February 20 2009

News of “The Donald’s” bankruptcy filing in Atlantic City was immediately countered by “The Donald” saying it was only a licensing deal representing less than 1% of his net worth. Representing a little more than 1% however is his latest project in Chicago, which brings to light the problems in the mezzanine financing market. Mezzanine debt fits between equity and 1st mortgage debt on the balance sheet.

The “Mezz” market is in the news these days because of the rising default rate among this type of financing. “If you count the total number of mezz loans there are, you have gotten close to the number of mezz loans that are going to have problems” Mission Capital Advisors’ David Tobin says.

Mezz financing is attractive to some investors as it could produce returns in the teens if levered and if the borrower defaulted the investor had the right to take over the property. “We were very comfortable when we underwrote these assets, if we end up owning them, then that’s just great.” Mark Nunneley, CAO of Ashford Hospitality Trust Inc. said in November of last year.

Great until you take over a property and the property stops generating enough cash to cover the 1st mortgages, no less the mezz debt. Other well known funds that are involved in the mezz debt market include FortressInvestment Group LLC, Fillmore Capital Partners LLC and Petra Capital Management.

To the extent that this will prove a money losing proposition for the hedge funds and private equity firms out there, a provision in the stimulus package could land up making all that back and more.

Sen. Max Bascus helped pushed through a measure on the stimulus bill that allow companies restructuring debt to defer possible taxes for as long as five years and then pay those taxes over the following five years.

The ultimate cost of the program to the Treasury was estimated to be about $1.6BN with ultimate being the operative word. The near term cost (next 3 years) will be closer to $42BN as the loss in tax revenue is front loaded and the receipts back loaded.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.19.2009

Credit Market Overview
February 19 2009

“In some ways, what the government says or does is becoming less important, since the market wants to see proof that the stimulus is working and the economy is bottoming.”

Although this quote by James Paulsen, chief investment strategist at Wells Capital Management, was made in time to be in last Saturday’s Barron’s it’s prescience rang true this week as Tuesday’s signing of the American Recovery and Reinvestment Act and yesterday’s mortgage relief plan were met by a two day drop of 38.42 S&P points or a 4.64% reduction from last Friday’s close.

Economists too are in synch with Mr. Wells. A recent poll of 52 leading economists by the WSJ shows that a previously hoped for “second-half recovery” is now looking much less likely. In September that same poll showed a consensus estimate of 1.2% of GDP growth in the 1st quarter of 2009. A more recent update puts this statistic at a 4.6% decline. Growth estimates for the April through June period has moved from up 1.9% to down 1.5% between the two sampling periods.

Responses by these economists regarding the stimulus package included the following: “too late”, “provides too little boost”, “trivial”, “too big” and “too small”. Those last two are probably the reason Harry Truman pleaded for “a one-armed economist”.

In response to statements that everything starts to clear up in the second half of 2009 David Shapiro, an economist at Penn State, said “If you look at the magnitude of this problem, the amount of debt relative to income, the credit and asset bubbles that have now reversed and it’s only just started, why is it going to end two quarters from now? To say ‘off we go’ in the second half of the year, I think that begs incredulity, I just don’t buy it. It’s a global thing, too; trade volumes are just cratering and our exports are getting pounded. There’s no where to hide.”

Brian Fabbri, chief economist at BNP Paribas agrees saying: “We’re in trouble. We don’t have sufficient economic plans at present to resolve the banking system or the financial crisis, and the stimulus package seems loaded for 2010.” Brian also sees the global nature of the downturn, increased savings by U.S. consumers and tightened lending standards as obstacles to a quick recovery.

Enjoy the week.

Jim Delaney

C.M.O. 2.18.2009

Credit Market Overview
February 18 2009

One of the keys to successful investing it is said is to follow the “smart money”. This used to mean (before 2008) do what the professionals do when they do it, not what the individual investors do when they do it.

In this context a story in yesterday’s WSJ seems apropos in that individual investors have been big buyers of high-yield paper and as a result have pushed yields down to around 11% from rates in the high teens seen during the 4th quarter of 2008. Fund researcher EPFR Global says individual investors have purchased more than $4BN of high-yield bond funds since last November.

For all of their lack of sophistication it seems that individual investors are getting the joke as the WSJ also reported that money-fund assets have grown by $450BN since last September and are close to their all time record of $4TN.

Put most of your money in a safe bet and take a flyer on a small portion that if it works out will boost the performance of your whole portfolio by some incremental amount. A strategy like that would have worked wonders last year and to the extent we’re not out of the woods yet it can’t be said it’s the worst strategy for 2009. Maybe some of these people should be running hedge funds.

Now before the rest of us start feeling like we missed something there is a “fly in the ointment” and that is that high yield bonds pay high rates of interest because they have high rates of default. No risk, no reward and vice versa.

The economic situation at the moment seems to be raising the risk of defaults as Circuit City (11/10/2008); Nortel (1/14/2009); Tribune (12/8/2008); Pilgrim’s Pride (12/1/2008); Smurfit Stone (1/26/2009); LyondellBasell (1/6/2009); Spectrum Brands (2/3/2009) and VeraSun Energy (10/31/2008) have all filed for Chapter 11 bankruptcy since 4Q08.

To further the point the three main credit rating agencies expect default rates to hit levels last seen in 1933 according to Moody’s Investor Service’s 87 year’s worth of default data. According to the WSJ, as of 2/6/2009 U.S. companies have defaulted on $43.1BN of high yield and bank debt, which the article goes on to say, is higher than 2006 and 2007 combined and is more than 25% of the $157BN of high-yield loan and bond defaults in 2008.

Hitting the dollar volume of defaults in two months that it used to take three to achieve puts us . . . well . . . I was going to say it but Jeffery Werbalowsky, co CEO of investment banking firm Houlihan Lokey Howard & Zukin beat me to it, “You do the math, we are in the midst of the greatest pool of defaulted debt we have ever seen.”

Enjoy the week.

Jim Delaney

C.M.O. 2.17.2009

Credit Market Overview
February 17 2009

In life, business and of course trading it is always good to learn form your mistakes. It appears Moody’s has taken this to heart as after having rated a whole bunch of mortgage backed paper AAA that probably didn’t deserve a single “Z” (not that there is such a rating) they have now examined the sovereign debt market and come up with three sub-categories for those countries whose debt they put on their top-shelf.

The categories are “resistant”, for those nations that are unlikely to be downgraded by the current global crisis; countries that fall into this category include Germany, Canada and (can you believe it) France. Their next category is “resilient”, for those nations that are being affected by the credit crisis but should be able to adjust and get themselves back to “resilient” status. The U.K. and ourselves fall into this category. Then there are those nations Moody’s deems “vulnerable”, with Ireland and Spain being the best examples.

The criteria Moody’s uses to decide which bucket a country belongs, or more importantly, what the cause of a downgrade could be are the material deterioration in the affordability of the debt, a deterioration in affordability relative to other sovereigns and the inability to correct the problem.

So after hearing about this I looked up the CDS spreads for the countries in question to see what the market thought. Germany trades at the lowest number of basis points, 70 with France in 2nd place at 74.5. I couldn’t find Canada’s CDS spread on Bloomberg but it might be tough to default on snow. In the next category the U.S. and U.K are trading at 87bps and 151.6 respectively while Spain is trading at 160 and Ireland at 376.63

87bps doesn’t seem that far away from 74.5bps which is France’s 5-yr CDS level but it does seem pretty far away the U.K.’s 151.6 so it’s not clear that the market agrees with Moody’s but it will be interesting to see how things change as the ever increasing deficit is financed through ever increasing quarterly refundings of U.S. Treasuries.

Already cognizant that the deficit is on its way to “way too big” Barack Obama has scheduled a “fiscal-responsibility summit” for February 23rd. On Friday the President told business leaders at the White House: “We are not going to be able to perpetually finance the levels of debt the federal government is currently carrying.”

This seems to be a realistic assessment but the risks taken by passing a massive spending bill can only be increased if an attempt is made to recover the spent monies too quickly. Christina Romer, chairman of he White House Council of Economic Advisors sites the “seesaw” nature of spending in FDR’s New Deal when Mr. Roosevelt would spend big one year and then back away the next, never allowing the economy to really get traction.

If this was never done before all arguments would be equal because the outcome would yet to be unknown. Given the mistakes made with the New Deal it doesn’t look like the government has learned from its mistakes. Hopefully Moody’s has.

Enjoy the week.

Jim Delaney

C.M.O. 2.13.2009

Credit Market Overview
February 13 2009

The line “Misery acquaints a man with strange bedfellows” in William Shakespeare’s play The Tempest is best now known to most of us as in its modern form as “Politics makes strange bedfellows”.

The truth behind this statement in either form gathered strength yesterday as news of a meeting hosted by (you guessed it!) Goldman Sachs with the people key to getting the toxic assets off the balance sheets of the country’s major financial institutions (you guessed it) the same people who helped put them on, met with Tim Geithner to figure out how to execute the transaction.

It took the talking heads on TV about 9 milliseconds to start screaming about how TG is too close to his Wall St. buddies and the government is, once again, handing the keys to the hen house to the foxes. Charlie Gasparino tried to make the story into the hottest thing since Jessica Simpson’s “20 pounds in eight weeks” claim.

Meantime Bloomberg quietly reported that the meeting had been scheduled for over two months and that the timing only seemed questionable due to the delay of TG’s confirmation due to that nasty tax issue and not announcing his plans on Monday, as originally scheduled, because of last minute wrangling over the stimulus package. (You think Mike has higher office in mind?)

Say what you will but if New York was a maximum security prison and you did need to get out, who else would you want by your side but Snake Plissken?

The S&P closed above a down trend line many were watching on February 6th & 9th and spent part of yesterday through the bottom of an up trend line those same people had their eye on. The buzz going into yesterday’s close was about money getting thrown at the mortgage problem with FNM and FRE getting involved to house the dreck. Anyone remember the “Superfund” set up by the EPA after the Love Canal debacle?

In CDS land, spreads ain’t buying any of what Geithner or Goldman is selling. Unemployment is rising; people who don’t work can’t spend money like they do when they are. The last time I heard Louise Yamada she was telling everyone to sell all rallies until the Dow hits 6,000 or further notice.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.12.2009

Credit Market Overview
February 12 2009

After losing the election for Governor of California by almost 300,000 votes in 1962 Richard Nixon gave an impromptu concession speech the next morning saying to the press, whom he blamed for favoring his opponent Pat Brown, “You won’t have Nixon to kick around anymore.” Given the how things were in his final days as Treasury Secretary it would not be a stretch to think that Hank Paulson had similar sentiments.

Where the problems stopped for HP, however, they seem to be picking right up for poor ‘ol TG. If early indications hold out we might see a little more efficiency from Mr. Geithner as his renaming of TARP now only takes three letters FSR. Unfortunately the latter actually takes more effort to say. Let’s hope the rest of his accomplishments do not appear to be one thing while being something harder and not easier.

It would also appear that Timothy’s plight is creating a lot more frustration than sympathy by both Washingtonians and Wall Streeters. Christopher Dodd (D., Conn) is placing responsibility for the fix on the Treasury and the current administration saying that it is their job to “reassure the American people that their money is in good hands. The public simply has no understanding about how government assistance will help, if at all.”

Not for nothing but that is not how I want one of the guys who has just voted to spend +/-$800BN of my taxpayer money talking. Comments like that seem an early indication that even the Democrats that voted for the biggest stimulus spending bill in history don’t know if it will work. (Maybe he went back and read Treasury Secretary Morgenthau’s notes?)

Wall St. too is unimpressed by the efforts of the new kids in town. Douglas Dachille, CEO of First Principles Capital Management thinks, “The uncertainty the government has created has made it nearly impossible to price many securities.

The plan to have private equity get involved sounds great on CNBC but you have to remember. The P/E guys get their votes by delivering solid returns not pork so to think they’re going to get involved before the rules of the game have been laid out is a little naïve on whose ever part thinks that’s the way it’s going to happen.

One person, while not necessarily in Mr. Geithner’s corner, at least seems to appreciate his predicament is Sen. Robert Bennett (R., Utah) who described Tim’s challenge “as nasty a briar patch as anyone has ever tackled.”

Enjoy the week.

Jim Delaney

C.M.O. 2.11.2009

Credit Market Overview

During the most of 2006 and the beginning of 2007 the demand for fixed income securities was such that investors were forced out the maturity and credit curves, sometimes simultaneously, to achieve whatever incremental yield they could obtain.

The CDS market saw a ratcheting in of spreads during this period, which would normally be good for equities but at times the stock price of the company in question declined along with spreads as well as bond and stock investors did not appear to be in synch.

Something similar is happening in the credit markets at the moment but this time for a different reason; CDS spreads for a good portion of the names in the CEC universe have come in since late January but the stocks have not rallied and in fact, most had a quite horrible day on Tuesday.

Every cross-asset relationship goes through periods when it works and other times when the answer to that question is “not so much”. This is one of those N.S.M. times but beyond the simple observation the question “why” needs to be asked.

Part of the answer comes from something I have written about often recently, the relative “cheapness” of corporate paper on a spread basis. That CSCO could issue $4BN in debt this past Monday, made up of $2BN of 10-year notes at 200bps over Treasuries and $2BN of 30-year paper at 225 bps over is testament to the demand for quality corporate paper. My CDS pricing source does not list 30-year CDS but the 10-year spread for CSCO was 96.3bps on Monday. This still shows some hesitancy by investors to use balance sheet space but that is a story for a different day.

CSCO is rated A1 by Moody’s and A+ by S&P and I think its safe to assume for the sake of this argument that since CSCO is not some CDO^2 that the two rating agencies have this one right. Additionally there have been $78.3BN worth of investment grade bonds issued in 2009 that were not supported by a government guarantee. (More evidence of demand)

The other part of the answer comes from looking at where spreads were and why they were there. Back on December 2nd of 2008 HPQ issued $2BN worth of 5-year paper but needed to pay a spread of 460bps over Treasuries to attract buyers. HPQ is rated A2/A so while slightly less credit worthy than CSCO the shorter maturity probably evens the rating difference out and we see that there was much more fear and less demand back in December. (The 5-year CDS spread for HPQ was 107.7bps at the time.)

Using these two debt issues as examples we can see that some of the fear has come out of the market and as that has happened the demand for paper has increased.

Stocks on the other hand are not enjoying the same resurgence. Many well known investors have been quoted in the media as saying that the stock market won’t come around until the credit market does, this makes sense given where the two asset classes reside on the balance sheet. The demand for paper is encouraging but the difference between CDS spreads and where corporations have to issue still shows some problems there.

People have also said that the “financials led us into this mess and they will have to lead us out”. I am not here to say whether those people are right or wrong but with the likes of BAC down 19.30%, C down 15.19% and WFC down 14.22% yesterday if they are correct we have some work to do.

Enjoy the week.

Jim Delaney

C.M.O. 2.10.2009

Credit Market Overview

British Prime Minister Gordon Brown used it last week to describe the global economy but then it was called a slip of the tongue. Now IMF chief Dominique Strauss-Kahn is saying it about the world’s advanced economies: the U.S., Western Europe and Japan. What is it? The word depression.

Larry Summers disagreed on This Week with George Stephanopoulos saying “we were really in a very different situation then” the Great Depression.

The CIO of Bridgewater Associates, Ray Dalio, couches it slightly differently in Barron’s this week saying that what we’re going through is a “D-process” which to Ray is the combination of deflation and deleveraging and he says comparable periods are the Great Depression, the Latin American debt crisis and the Japanese experience.

Simon Johnson, former IMF Chief Economist and professor at MIT’s Sloan School of Management says the term refers to any significant contraction that lasts around 5 years.

What ever you do land up calling it Timothy Geithner is planning to announce measures today to fight its effects. These will include re-naming the TARP plan because it carries such negative connotations. Possibly of slightly more import are also plans to have the private sector become investors in the securities with the Treasury back-stopping losses over a certain threshold.

Industry people have a number of issues with the points that have been leaked so far including that it deals only with banks in the proper sense and with none of the institutions Bill Gross and others call the “shadow banking system”. Real banks it seems only account for 20% of the U.S. private credit market these days down from 40% in the 1970’s per Bianco Research in Chicago.

Vincent Reinhart of the American Enterprise Institute is a bit more acidic in his description saying, “What we need is a shock and awe campaign to fix the credit markets and what we’re getting instead is ‘aw shucks.’”

I have talked often in this space regarding the spreads on corporate debt at the moment and how, on a spread basis, they imply default rates exceeding those of the worst years of the Great Depression. Bill Gross echoes this sentiment and adds that the default rates could become self fulfilling prophesies if non-investment-grade corporations are forced to roll-over long term debt at levels of 20% or more.

There is a lot riding on Mr. Geithner’s plan. Let’s hope its more of Mr. Reinhart’s shock and awe and less of his aw shucks!


Enjoy the week.

Jim Delaney

C.M.O. 2.9.2009

Credit Market Overview

From what has been published it appears that barely 1/5th of the stimulus that Congress passes will be spent in fiscal 2009 and with just 3% of that being anything that you could honestly call stimulus; Rohm Emanuel’s “never waste a good crisis” seems to be gaining momentum while Larry Summers’ “targeted, timely and temporary” seems to be losing it.

The market added 22.75 S&P points on Friday as anticipation that Timothy Geithner was now both current on his taxes and was going to announce his plans on how to clean up the financial mess on Monday. In comparison the S&P moved 98.69 points on the Thursday and Friday preceding the Monday when Hank Paulson was going to announce TARP 1.0.

Given that the market was 148.69 S&P points lower by the 29th of September and 345.16 points lower by the 8th of the following month maybe Friday’s smaller number will mean that the move from here will only be down 78.63 points once the market realizes that anything short of the Swedish good bank/bad bank approach will to little more than prolong the pain.

Just to close the loop on all of the index math 78.62 points would put the S&P at 789.97 near but not exceeding the November lows. The test many are expecting which also reduces the probability of it occurring.

High yield spreads moved from 1494.4 on Thursday to 1444.3 as of Friday’s close as measured by the CDX indexes published on Bloomberg. Investment grade spreads moved back below the 200 line again as the spread players in the debt market are swallowing all the bonds they can while the relative cheapness lasts and corporate treasurers and CFO’s are issuing as fast as they can while nominal yields are at close to all time lows.

Something else to keep in mind, the market had 6 counter trend rallies of at least 20% in the 30’s before the market had erased 89% of its pre-1929 value. As of Friday’s close we are down 44% from the October 2007 high and have had one.

In a sidebar in Barron’s this week Charlie Minter and Marty Weiner of Comstock partners did an analysis on the “E” of the P/E of the S&P. The last paragraph says it looks like 640 is a real possibility.

Enjoy the week.

Jim Delaney