The Credit Spreads Blow-Up

[Excerpted from Bill Cara's Daily Report]

The blowing up of credit spreads, as seen in the above graphic, is an indicator of the level of risk aversion in today's capital market. Without solving the credit crisis, there is likely to be profit-taking following every brief period of bullishness. We are seeing that today.

Corporations can't afford a 2000 basis point credit spread, which is double previous worst case scenarios. Without a solution to the credit crisis, there will be a flood of Chapter 11 bankruptcies in the US. There will also be an extended period where traders remain earning nil income from US Treasury Bills, which is a destruction of wealth.

On October 16, I published a Survivor's List of zero- or low-debt companies that appeared to my Belgium-based colleague Pascal Willain and me to be stocks worthy of consideration during the long-term cycle bottoming process in equity markets.

Hopefully, the Obama A-Team can attack the credit spread problems.

Comments

[jepittman:]

This is a very revealing graph. The question is how long does it take to thaw the credit markets and narrow these spreads? The author suggests it had better be soon or the bankruptcies will accelerate. This is the motive behind the 'quantitative easing' by the fed. It is also the motive behind the coming huge fiscal stimulus bill. One can bet either way. Either things start to get better within a very few months or they will get progresively worse. Congress and the Fed seem to no longer be in denial, nor do policymakers in Europe and Asia. It appears the better bet is for the spreads to begin to narrow soon.

2008 Dec 01 02:48 PM

[_vagrant_joe:]

while a normal capitalistic system should seem to favor those with strong balance sheets and reasonable or negligible debt, our current system and those of many of our european counterparts seem to be shunning the predictability of capitalism in favor of russia's oligarchical corporatism -where politics and political friends matter almost as much or even more than sound business practices. The only predictability of this system would seem to be disaster -but when, where, and among whom are unknown. When a company such as Citi can take $20B from the US Government, an amount equivalent to their entire market cap, only give up 4.5% of their company (in the form of warrants), and then use that money to buy other companies -the idea of capitalism as the United States' working model is turned on it's head. And this scenario has happened at an alarming rate (even though just 1 instance should be alarming in an of itself). This has an unknown effect on companies that play by the rules. Those playing by the rules might have the most to lose as their balance sheets can just be a good meal to a competitor with more or better-connected lobbyist/bribery-artis... and a blank check from a Chris "countrywide" Dodd, Barney "fannie-man" Frank, Nancy "JPMorganGoldmanSachsC... Pelosi, or Hank "hug-a-bank" Paulson, et. al. If a competitor that is doing worse that you, suddenly is able to use their fragility as a reason to pick up a check larger that the value of their entire company, buy out suppliers/distributors... or whatever with no restrictions, then these scenario's need to be factored into portfolio decisions.

2008 Dec 01 03:08 PM

[Glen Bradford:]

First time i've seen that chart. It explains a lot. Maybe you should chart it against the S&P 500.

2008 Dec 01 04:46 PM

[SW Richmond:]

I have to ask: are the high rates quoted to businesses the result of expected quantitative easing? Everyone knows that dollars are being printed at breakneck speed. This is known to lower the buying power of dollars in the future (current dollar strength being temporary in nature), so if I were to loan dollars over the long term I would want a high rate of return to make up for the lost buying power realized over the term of the loan.

Everyone is interpreting the chart as a result of "flight-to-quality", but couldn't it also be seen as currency risk? And isn't the currency risk in fact caused by the quantitative easing?

2008 Dec 01 05:43 PM

[JasonC:]

If it were currency risk it would appear in T-bill yields, which instead are zero, and in spreads of inflation adjusted treasuries over straight treasuries - instead those are reversed. It is not inflation expectations, there is no expectation of inflation, there is actual and prospective deflation at ferocious rates.

The wide spreads reflect both a fear of high rates of default and the destruction of all risk taking capital in the credit markets. Either the Fed steps in and takes credit risks, or nearly every existing company is bankrupt.

I can personally, today, lend money to major banks for twice the rate they are willing to lend money to me. Meanwhile those with nearly unlimited funds are only willing to lend to the US government, and are willing to do so at 1%.

2008 Dec 01 06:14 PM

[Alex Filonov:]

'Hopefully, the Obama A-Team can attack the credit spread problems.'

What if they fight back?

2008 Dec 01 09:50 PM

[User 290548:]

The only misleading thing about this chart is that today is not 1990 or 2003. The dashed line on the right might still be climbing going forward unitl a market bottom is reached.

2008 Dec 02 05:18 AM

[{5U}:]

It amazes me people invest in stocks without understanding the credit markets


On Dec 01 04:46 PM Glen Bradford wrote:

> First time i've seen that chart. It explains a lot. Maybe you should
> chart it against the S&P 500.

Jan 01 05:41 PM