Credit Market Overview: Making It Through 'The Cruelest Of Months'

by: Jim Delaney

“If you had bought Swiss francs when I suggested, you would not have lost three-quarters of your fortune.” Those words, spoken by the banker of Anna Eisenmenger, a middle-class Viennese diarist in post-WWI Vienna are as apropos today as they were when they were originally uttered, and although Anna had taken her lumps in the sovereign debt of Austria, another excerpt from this same conversation is equally telling: “Surely there can’t be anything safer than [government bonds],” to which her banker replies, “But, my dear lady, where is the State which guarantees those Securities to you? It is dead.”

These tidbits are from a new book by Sylvia Nasar titled Grand Pursuit: The story of Economic Genius, which was reviewed by James Grant of Grant’s Interest Rate Observer in this weekend’s WSJ.

With yields on Greek two-year notes hitting 48% this week as Hellenic 10-year paper yielded 18% and the probability of default reached 90%, it would appear there are soon going to be more than a few “Annas.” And all of this while September still has three weeks to go!

Speaking of September (and how it usually goes), Bespoke Investment Group looked at the numbers and found that when the Dow declines by 2% or more in the first three days (it dropped 4.08%), it has averaged a 6.31% decline for succeeding 27 days. When the decline was 4%, the average decline was 13.5%. Averages can be a bit misleading, so a closer look at what makes up this second statistic is warranted. There have been three previous cases since 1900 when the Dow dropped more than 4% in the first three days. In 1931 the rest of the month produced a 27% decline; in 1946 the number was -4.83%; in 2002 it dropped -8.35%. It is obvious from this that the rout during the Great Depression has skewed the average, but trend is not pretty to start with.

The release of the Fed’s Beige Book last week did little to build confidence that the markets will produce an outlier in September, as while overall consumer spending rose in most parts of the country, a large part of that was driven by automobile sales. The question that needs to be asked, however, is what part of that was a reflex from the slowdown in manufacturing caused by the earthquake in Japan in March? Sales of other big-ticket items, including furniture and appliances, were said to have slowed during the period, and businesses said they thought “heightened consumer anxiety was weighing on sales.”

Home builders also reported weakness as customers stopped showing up for open houses, and in some cases backed out of deals. One Philadelphia area builder said that “you could hear the crickets for two weeks.”

To be fair, there were some bright spots. Sales of luxury items remained strong, so we can rest easy that the Marie Antoinettes of the world are well insulated from the turmoil. Job growth was said to be stable, but with unemployment at 9.1% I am not sure that offers any consolation.

The Boston Fed noted that “one contact saw a pronounced downward sales trend in recent weeks that he attributed to consumer concerns about the debt ceiling debate, stock market gyrations, ongoing unemployment, and continuing unease about the U.S. economy’s medium-term prospects.” Nothing there that can’t be fixed easily.

It would seem the only thing not mentioned by the Boston Fed’s contact was the sovereign debt crisis in Europe, which also seemed to take a turn for the worse last week as Jurgen Stark, the ECB’s chief economist, announced his resignation effective 12/31/2011. The reason given was “personal,” but the markets took that to mean Jurgen had some ideological differences with the direction he thinks the ECB is headed. In an op-ed for the German business daily Handelsblatt released late Friday, Stark wrote that "government efforts to save the eurozone have fallen short”. He called for a “far-reaching reform of the mechanism for decisions and sanctions.” That news moved the DAX index to its lowest level since July of 2009 and the FTSE MIB index in Milan to a new two-year low. “At the very least, this adds to the uncertainty and to the sense of division among European policy makers,” said Greg Fuzesi, an economist with JPMorgan Chase.

Here at home we were treated to President Obama’s next plan to save the world in the form of a $477 billion “jobs” -- read: stimulus -- bill, during which he repeated the phrase “pass this jobs bill” 10 times without saying the word “stimulus” once. Watching the joint session of Congress during the speech, few had on their poker faces, as the Democrats were clapping at every pause while John Boehner and company were all clenched jaws and pursed lips.

With 19 days left in what is normally called “the cruelest of months” for the stock market, and in an environment where correlations between individual stocks as well as entire asset classes are at an all time high -- and the “risk-on/risk-off” trade is being flipped like a 5-year old playing with the light switch -- it should be an interesting ride. Hang on.