The Credit Market Indicator: Don't Buy Stocks, Yet

by Eric Roseman

I've been saying this all year: If you want to know when to buy stocks again, you must watch the credit markets. You also have to keep an eye on key indicators like the LIBOR and mortgage rates.

As I said yesterday, the U.S. markets have been recovering since they hit another intermittent low on July 15. But over that time, the credit markets have actually been declining.

So let's take a closer look at the credit markets and review last week's strong stock market action.

Basically, if we're seeing a big stock market rally, then we should also see a rally in yield spreads. In theory, a stock market rally means the risk-taking environment is improving. If investors are lunging after stocks, including the banks, then credit markets should also thrive.

Last week, the Dow gained 2.9% while the U.S. dollar had its best weekly rally in six years. Commodities prices continued to nosedive. That sort of bullish price action for stocks and the dollar should have driven non-government bond yields sharply lower. But that simply didn't happen.

From August 1 to August 8, 90-day LIBOR rates climbed only one basis point from 2.79% to 2.80%. And 30-year fixed rate mortgages climbed from 6.35% to 6.55%.

The only segment of credit that posted a rally last week was investment-grade corporate debt where yields declined from 6.08% to 6.05%. That's not exactly a huge gain.

Finally, what really irks me about this rally is the Treasury market.

On big days for stocks, like last Friday, the benchmark 10-year Treasury bond posted a modest loss or a decline of 4/32nds. Typically, a big stock market rally would drive Treasury bond yields much higher because investors dump staid T-bonds for equities.

Heck, if the world is chasing stocks doesn't that suggest we're growing more bullish on the economy? It doesn't look that way.

The fact is T-bond yields were unchanged from August 1 to August 8 while stocks gained 3%. This tells me bond investors don't believe we're at a stock market bottom. In fact, intermediate Treasury bond prices are unchanged since July 15 as stocks have rallied.

There's something fishy about this equity market rally.

Examining credit markets is not an exact science nor is it a perfect forecasting tool. But it sure beats the stock market where crowds of neurotic and momentum-based investors chase daily trends to make a buck.

My diagnosis: It's still not the time to fully embrace equities. Listen to credit.

Comments

[Ranajit:]

I think the yield has not improved with stock market because there is an expectation that in future the interest rate will be higher, because the inflation pressure has not abated yet.

2008 Aug 13 01:40 PM

[Chuck Okie:]

It's hard for equity markets to rise unless the economy is growing, and it's hard for the economy to grow unless credit is expanding. And credit isn't expanding, it's contracting.

2008 Aug 13 02:19 PM

[wdhalgren:]

The fed is pumping enough liquidity into financial markets to rally stocks while still supporting bond prices. Bennie "Bubble" Bernanke has determined that we need higher stock prices and lower bond yields at the same time. Wouldn't want those mortgage holders to be faced with higher resets. Gotta reflate that housing bubble, immediately. During the depression the slogan was "a chicken in every pot". The modern version is "a house on every plot".

This is the golden age of government support of every facet of our financial well being. Next comes the dark ages.

2008 Aug 13 06:11 PM

[GreenAB:]

for the threasuries not falling enough: i think a substantial part of the money coming out of commodities moved into treasuries as the inflation outlook is improving.

2008 Aug 14 08:09 AM