Credit/Bank Woes Tank Equities
A: The credit tsunami is starting to really hit stocks as deflation of credit shows how it could affect corporate profits in the near future. Looking at the credit market indicators, it appears that we are entering fearful territory again; new lows in ABX's, rising TED spread (hat tip CR), widening of corporate spreads, rising 1-Wk LIBOR, and broken technicals on stock indexes. We just can not discount the possibility of another crisis of confidence bringing down a big bank or brokerage house in this environment. With balance sheets in disarray and capital raising and deleveraging a must, when you get this mix of ingredients, capitulation or an event becomes likely.
The Volatility Index (VIX) is only around 24, but the trader in me is starting to feel that pit in your stomach; just hit me today. Back in the day, this 'feeling' got your eyes wide open, expecting either an event, a big bounce, or a capitulation (fierce selloff) to get out the weak hands and flush the system. So, I'm certainly keeping tabs on the market and I'm sure big media will jump on board too with headlines like "....STOCKS DIVE! OIL HITS NEW RECORD...", spreading the word to masses.
Here are the deteriorating signs in the credit markets, telling us that once again banks are likely to get very stubborn with their lending and nervous about their struggling holdings of assets that trade in out of favor illiquid marketplaces:
a) Markit's ABX-HE-AAA reaches new lows (indicating eroding sentiment for residential mortgage back securities as defaults expected to rise; discussed 9 days ago)
b) TED Spread rises to 1 (difference between 3-Mth T-Bill and 3-Mth LIBOR; normal around 0.5, the higher it goes the higher the perception of credit risk. As US treasury's are considered risk free, and 3-Mth LIBOR starts to rise, the gap between the rising rate and the stable/falling one grows indicating increasing credit risk being priced into lending rates. Risk of default rises as TED spread rises)
c) 1-Wk LIBOR perks up; (rate that banks willing to lend at with each other is rising again)
d) Corporate Spreads widening again; pictured below (Markit CDX.NA.HY widening)
e) VIX rising
f) Fed's latest auction got oversubscribed
WIDENING CREDIT SPREAD BETWEEN WACHOVIA HIGH YIELD CORPORATE BOND INDEX vs iSHARES LEHMAN 7-10 YR TREASURY BOND FUND
CHART LINK VIA BLOOMBERG: Simply add "IEF:US" symbol to this chart to see widening spread.
Bond yields came down with stocks and the 10-YR gave back about 23 basis points in the past two weeks; so we will likely see a bit of relief in the mortgage markets UNLESS this IS another wave of the credit crisis and a re-pricing of risk is built back into lending rates for residential mortgages; if that should happen, the gap between conforming and jumbo will rise again and we won't see as direct a relationship between lending rates and the falling 10-YR yields, as we have over the past few months. Certainly crazy times.