New Day, Same Stuff

Via Peter Tchir of TF Market Advisors

Once again equities are responding to events with more excitement than the credit markets.

Yes, Germany approved the changes to EFSF first announced back in July.  That was fully expected and a No vote would have been a shocking disaster at this stage.  The level of cynicism has hit a new high.  I have heard a lot of chatter that now that Germany has jammed this through, they can stop pretending that they are against levering up the funds.  I am not a fan of the politicians or political process, but betting money that Schaeuble and Merkel made such bold-faced lies seems like an act of desperation.  The risks from pursuing the leveraged EFSF strategy are real and high - downgrades of all the top European countries and inability to stop any renewed selling pressure in the future.  Germany has the sense not lose their rating in a futile attempt to defend a perimeter that can no longer be defended.

We had a bit of positive data today.  Though the fact that the usually optimistic BLS took the time to point out the data may have had a weird seasonal adjustment should dampen the enthusiasm.  This is a group that has under-reported intial claims so many times in a row that is beyond comical, so they have a tendency to sugar coat the truth - and here they took the time to downplay a good number.  The market loves discarding the number when it is bad but affected by things like the weather, but is happy to ignore today's caveat.

Taking a look below the surface reveals that the credit markets are still struggling.  Bond volumes are low and are not participating in rallies.  This is in part because of continued supply pressures.  Corporations need to come to market, as do companies.  The secondary bond market can remain in limbo and quote prices that make everyone comfortable.  Down enough that no one is too eager to short an individual bond but not cheap enough where real demand would come.  New issues are coming at concessions, and until the market can absorb a new issue without a significant concession, spreads will not perform particularly well.

HCA came with a 8% 7 year bond on Tuesday.  It was priced at par and is now trading at 98.5.   It was only a $500 million issue.  To put that in context, back in July HCA priced a 7.5% 10 year bond.  It was a $2 billion issue and traded up.  So the bond was bigger, had a lower coupon, far lower spread (treasury yields were higher than), and longer maturity, yet the market absorbed it and wanted more.  A lot has changed in two months and equities are free to resume their march back to 1,200 but I think this HCA deal is a great example of how weak credit really is.  If you want to get long risk, high yield seems more attractive than stocks.  That market is down almost as much year to date as the SPX, and yet does have downside protection.

Over the past two years we have seen story after story about how much cash companies have on their balance sheets and how robust the corporate bond market has been.  A portion (I think large portion) of that cash has come from issuing bonds.  Those bonds have maturities and have to be re-financed.  That will be a source of supply in addition to those companies that actually need money.

The weak Italian auction is also another source of overhang.  How can an auction be a sign of more supply coming?  Italy did not raise all the money they wanted or needed.  They will be back for more.  They didn't want to pay the premium required to get a bigger deal done.  They still need the money and will be back, and given their ability to "time the markets" they may regret not taking money at these rates when they could have.  They too are waiting for the EFSF to lend them money.  Yes, Italy can't wait to guarantee the EFSF so that the EFSF can borrow money and then lend it to Italy.

The CDS indices, which are about equally correlated with stocks as with corporate bonds in these hectic times are not responding well again today.  Main is unchanged and IG and HY are only a tiny bit better on the day.  For all the feelings of relief, BAC CDS remains at 400.  That is still close to its widest levels and is there because of its US problems, not because of Europe.  Yes, in spite of the focus on Europe, we have our own problems here and those have not been fixed by levered EFSF.

Some consistent good data, that doesn't rely on inventory build or weird seasonal adjustments would make me change my view.  Real strength and a deep bid in the credit markets would make me change my view.  Actual progress in European debt reduction or GDP growth would make me change my view.  Until I see at least one of the above I will continue to be bearish US stocks at these prices.


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