Does S&P's Top-Ticking Incompetence Mean It Is Time To Short Credit?

Today's Bloomberg has a good article on how S&P: that most reliable lagging market counterindicator has thrown in the towel, and is upgrading anything that moves. "Ford Motor Co., the world’s most profitable automaker, and San Jose, California-based EBay Inc. were upgraded by S&P along with 756 others, compared with 722 downgrades, according to data compiled by Bloomberg. In 2009, S&P slashed corporate debt grades more than three times as often as it raised them, the data show." The article continues: "S&P boosted grades for non-financial issuers 1.5 times as often as it cut them, while Moody’s Investors Service made 1.9 upgrades in those sectors for each downgrade, the ratings companies said." In other words, the crisis is all over according to S&P. Luckily, we all know one thing that the ratings agencies apparently don't: that when it comes to top or bottom ticking the market, there is nobody even in the same ballpark as these two business model relics (both of which only downgraded Ireland after the country became insolvent). Which is why, as the chart below, courtesy of Andrew Yorks, demonstrates, the time to go balls to the wall short credit is now.

Note the uncanny capability of S&P's upgrade/downgrade ratio to be the be the best leading indicator of inflection points in corporate bond returns.

The chart above is all one needs to keep in mind when reading the rest of Bloomberg's article.

About half of non-financial companies upgraded by S&P were rated in the B range and 16 percent were in the CCC or CC tiers, according to a Dec. 15 report from the New York-based firm.

The default rate for speculative-grade borrowers fell to 3.4 percent last month from more than 11 percent a year earlier. It may decline to 2.4 percent by September 2011, S&P said. Moody’s estimated this month that defaults may fall from November’s 3.5 percent rate to 2.1 percent next year.

Investment-grade spreads have contracted 23 basis points to 167 from 190 at the end of 2009, according to the Bank of America Merrill Lynch U.S. Corporate Master index. Companies will find it more difficult to improve their creditworthiness after cutting costs and taking advantage of investor demand for their debt to extend maturities, Diane Vazza, head of global fixed income at S&P, said in the report.

“We expect only modest revenue growth in 2011 and that margins will be flat to slightly down,” wrote Vazza, who didn’t return a telephone call seeking elaboration. “To this end, we would expect upgrades to slow in 2011 but downgrades to remain muted.”

Moody’s increased corporate debt ratings 742 times across all industries and cut them 847 times, Bloomberg data show. The downgrades include 97 rankings on hybrid securities issued by BB&T Corp., Fifth Third Bancorp and 30 other banks on Feb. 17, Bloomberg data show.

Bondholders may suffer in 2011 as cash-laden companies start tapping their war chests to expand, said John Hawley, a money manager in Des Moines, Iowa who helps oversee $22 billion of investment-grade bonds for Aviva Investors North America.

“If you just look at it from a balance sheet perspective, we’d think we’re pretty close to the top and would not expect it to get better from here,” Hawley said.

EBay, the largest e-commerce marketplace, was raised to A from A- by S&P on March 2. Moody’s followed on Aug. 19, boosting EBay to an equivalent A2. The change followed the company’s “good resilience during the challenging economic environment over the past eighteen months,” Moody’s said in a statement.

Ford’s unsecured debt rating was raised three times by Moody’s in 2011, to Ba3 from Caa1. The Dearborn, Michigan-based automaker, the second-biggest issuer of high-yield corporate bonds this year after Ally Financial Inc., sold $4.5 billion of debt through its Ford Motor Credit Co. unit at yields showing investors were betting it would be upgraded to investment grade.

Bottom line: if Moody's deplorable history of top-ticking the market every single time is any indication, it is high time to go short credit.

h/t @andrewyorks


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