Tuesday, September 14, 2010

Credit spread update

Our six Argentine friends departed this morning for a drive up Highway 1 to San Francisco, so blogging should be getting back up to speed this week.

To begin, here's an update on credit spreads. Following the Greek default scare that rattled markets and pushed spreads up in May, credit spreads have since settled back down. They remain quite elevated, however, and are still at levels that have been associated with the onset of recessions in the past. Things have been slowly improving on the margin, but the market remains quite nervous and fearful that a double-dip recession is lurking around the corner. Investors are still worried about the prospects of rising tax rates, and businesses are concerned that they face a harsh regulatory environment.

In short, spreads tells us that the market is still quite fearful. There is nothing here to suggest unwarranted optimism or unattractive valuations. If the news doesn't deteriorate as the market seems to expect it will, then spreads are likely stabilize or narrow further. This creates an attractive proposition for those willing to take some risk, because yields on corporate bonds are significantly higher than the yield on cash. The huge yield pickup to be found in the corporate bond market provides a substantial cushion against bad news, and if the economy fails to deteriorate or even improves just a little, then the rewards to holders of corporate bonds will be large.

No comments: