Comments on: On the Continuing Equity/Credit Market Disconnect

By: Steiny

Steiny — Thu, 21 Feb 2008 01:36:00 +0000

I don’t understand the graph that has been posted….from 2000 to 2003 the Dow collapsed from almost 12,000 to 7,4000 yet you had 3 points during that time in which the market “rallied”? Most people that held a diversified portfolio during that time got completely housed. Now we have a higher than normal probability that the Dow is going to rally from 12,400 to a new high of 14,800 (20% upside)?

By: Anonymous

Anonymous — Wed, 20 Feb 2008 18:51:00 +0000

Faced with this kind of conundrum, in practical terms investors are scratching their heads and wondering whether to be long or short equities.

Astonishingly, even uber-bear Nouriel Roubini, despite his predictions of an unprecedented financial meltdown, is reportedly 100% invested in equities.

By: UrbanDigs

UrbanDigs — Wed, 20 Feb 2008 15:46:00 +0000

Yves – I discussed this EXACT situation a week ago as CDX spreads widened big time!

For kicks, I plotted a MARKIT ABX index against the DOW and sure enough, the credit markets are LEADING equities!

http://www.urbandigs.com/2008/02/stocks_lagging_credit_markets.html

By: Anonymous

Anonymous — Wed, 20 Feb 2008 14:03:00 +0000

Problems in the credit markets are still largely technical due to structural flaws in structured credit products that are now being exposed. Equity markets do not have these issues hence the current disconnect.

The credit markets are largely closed now as participants try to figure out how these structural flaws can be fixed, if possible. The longer the markets are closed, the more fundamental erosion accrues, which we are starting to see. Then equity markets will become more correlated with credit.

By: Ginger Yellow

Ginger Yellow — Wed, 20 Feb 2008 10:50:00 +0000

This is nothing new, for this crisis anyway. Equities have lagged credit consistently over the last year.

By: Paul Amery

Paul Amery — Wed, 20 Feb 2008 10:49:00 +0000

This is exactly the same as what happened in September-November last year.

Equity investors are by nature inclined to optimism. They are also largely ignorant of the credit markets.

The continuing rise in CDS spreads can only be ignored for so long. When reality sinks in it should be good for another 200-300 points off the S&P 500.

By: Abby

Abby — Wed, 20 Feb 2008 09:15:00 +0000

Hi,
I’m an editor for Seeking Alpha and would appreciate it if you could contact me: acarmel@seekingalpha.com. Thanks.

By: Anonymous

Anonymous — Wed, 20 Feb 2008 08:14:00 +0000

I like ur analysis vy much and it has been my daily must read. Just saw Big Picture has put ur blog into “spotlight”!

Here is Greg IP’s reasoning on credit/equity divergence:

Credit spreads and stocks measure different things. No matter how good profits are, the upside for credit is limited: the best you’ll do is get back 100 cents on the dollar. But the downside is substantial: in a default, you could get zero. So an increase in default probabilities for even a small portion of the index can push the average yield up sharply, even if profits look fine for the rest. By contrast, stocks have a more symmetric response to changes in the profit outlook.

Another difference is that credit is always less liquid than equities and especially so nowadays with many of the natural buyers of credit nursing shrapnel wounds in their capital from the implosion of structured finance. So perhaps some of the widening in spreads reflects a higher liquidity premium.