Wednesday, July 15, 2009

Credit markets taking cue from the stock market

From Bloomberg:
Corporate bonds, loans and mortgage securities and asset- backed debt have all weakened or been stuck in ranges in the past three to five weeks on concern that markets strengthened too far, too fast. Yields on high-yield, high-risk U.S. company bonds rose to 9.69 percentage points more than Treasuries yesterday, after falling to 9.17 points on June 12 from 16.62 points on Dec. 31, according to Barclays Capital Inc. index data. Loans to the companies fell to 79.41 cents on the dollar, from 80.24 cents on June 12, Standard & Poor’s data show.

“It’s all sort of stalled out,” Jim Shallcross, who oversees about $14 billion of bonds as director of portfolio management at Declaration Management & Research LLC in McLean, Virginia, said in a telephone interview.

The credit markets in this story are viewed as somehow separate from the equity markets. But in reality the secondary credit markets look to 4 sources for "inspiration".

1. The primary markets: If demand for new issues picks up and new deals get priced differently from the secondary markets, the credit markets will respond.
2. Defaults and recoveries: Unexpected defaults, poor recoveries or unusual court actions will get the markets' attention.
3. Mutual fund flows
4. The equity market: Absent anything unexpected in 1 - 3, the credit market traders will take their cues from the most transparent/liquid proxy - the equity market.

One can give all sorts of explanations for the credit market rally, and recent sideways movement, but the reality is that the credit traders are mostly responding to the stock market. Here is a chart that shows the traded HY bond index (HY CDX), the HY loan index (LCDX), and the S&P500. Both the rally and the "sort of stalled out" part are simply following what the S&P500 has done.

This may be a sacrilege, but a possible way to think about the credit markets these days (particularly the heavily discounted non-investment grade) in a macro sense is simply as low beta stocks.

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