Thursday, June 24, 2010

Financial conditions are not all that terrible

This is a chart of financial conditions as measured by Bloomberg. It "combines yields spreads and indices from the Money Markets, Equity Markets, and Bond Markets into a normalized index. The values of this index are z-scores, which represent the number of standard deviations that current financial conditions lie above or below the average of the 1992–June 2008 period."

Yesterday the index registered -.92, which is better than the May 20th low of -1.53 and far better than what we saw in the runup to the Lehman crash. Swap spreads in the U.S. are about average, the Vix index is elevated (just under 30 today), and European swap spreads are elevated (2-yr swap spreads are just under 80 bps). The world is very worried about a Greek default or restructuring, as evidence by the 950 bps spread between 2-yr Greek and German bonds (bottom chart), enough so that it would be surprising at this point if Greece did not default; a significant default is effectively priced into the market today. In short, things could be a lot better, but this is hardly a crisis, disaster or a replay of 2008.


狂猪 said...

Hi Scott,

What is the mechanism by which the market can force Greece to default?

I've been really puzzled by this question ever since Europe committed to bailing out Greece. The $146bn bailout package guarantees Greece will not need to raise money in the bond market for 3 years. That would imply the high Greek 2yr bond yield can't affect the government's financing needs right?

It is also very puzzling that the Greek 2 yr bond yield is rising when the bailout package is for 3 years. I'd think the 2 yr Greek bonds are safe since Greece is unlikely to choose default within the bailout period.

I've been assuming the market can't force a Greek default for the last few months. It seems the market is keep telling me I am wrong.


brodero said...

On another note S&P 500 to GDP
is as of today at 7.36...Moody's
Baa yield is 6.20. Add the two together you get the March 9,2009 low the S&P 500 to GDP
was 4.80 and Moody's Baa yield was
8.29 for a 13.09 total...below 14 is cheap.

John said...

Both Oracle and Rimm have reported good earnings. Rimm's Board has reportedly authorized a 31 million share 'purchase for cancellation' resolution. Oracle's stock is up nearly 4% in after hours trading.

As earnings continue to come in over the next few weeks it appears a completely different view of economic conditions will emerge compared to the parade of pessimism that has bombarded market participants since the 'Euro collapse' scare (which has not happened) that accelerated in early May.

Public Library said...

On the margin, things are deteriorating in many places. We are entering the next phase of the cycle.

One in which Governments are seriously indebted, unemployment high, prices rising, wages stagnant, and taxes heading north.


You can't grow your way out of this one John.

Bill said...


So what does a double-dip recession look like if it happens? Is it as deep as the last one or shallow? I'm beginning to wonder if we're just going to have a lousy decade like the '70s. Even though we weren't in a technical recession every year, it sure felt like one for most of the time.

John said...


What you are offering is IMO hyperbole. I submit that all of the problems you infer are known by the market. Not only are they known, they have been known for some time. Ultimately, Mr. Market is a discounting mechanism. He takes all known information and prices securities based on the known data, emphasizing what he sees as the most pertinent at the moment. It is in constant flux.

Pessimism in in Vogue currently. "Analysts" are rewarded for analyzing the problems. By doing so they appear intelligent. Optimism is ridiculed and portrayed as naive. Bulls are shunted aside and relentlessly challenged. Bulls talk of 10% gains while bears direly warn of 50% losses, offering no specific data to back up their warnings. Non-professional investors are intimidated with the meltdown theory-of-the day with CNBC anchors breathlessly spoonfeeding slowpitch questions.

I recognize the problems the economy faces. I submit that if both you and I know this, the market likely discounted it days, perhaps weeks ago. I continue to believe the market is in a bottoming process and stocks (particularly higher quality ones) are becoming more alluring on a risk/reward basis. Further declines will offer investors an opportunity to accumulate high earnings streams at prices rivaling the March '09 lows. Short interest is high, cash on the sidelines is high, competing yields are virtually nonexistent and "Financial conditions are not all that terrible".

Color me increasingly bullish. Especially on further declines.

Scott Grannis said...

Bill: a double dip recession would look completely different from what is happening today. I see absolutely NO sign of a recession anywhere on the horizon.

Anonymous said...


Your reply is absolutely spot on mate, bears capture the media more because dire warnings of death and destruction always do lol.

İMO it plays on our human Psychology of fear, fear trumps all in the markets (if you let it) We humans are predictable beasts.

If CNN ran two documentaries,

A/ Shark attacks with lots of extra blood and screams etc.

B/ Nice fluffy lamb has good life avoiding the dinner table!!

Guess which documentary will have the most viewers lol

Thanks again Scott for what you do!!



Public Library said...


Analyst have 98% buy ratings and a $90+ per share target on the S&P 500. I would hardly call that bearish sentiment my friend.

I don't think we are talking about a massive recession here. The difference is in Scott's 3-4% projections and what I believe more likely, the 1% - 2.5% range. The latter will feel mighty bad all things considered.

Furthermore, I believe you discount the impact over time that a sluggish and languishing economy can have on sentiment. We do not need a technical recession for things to seem pretty bad. And the longer it goes on the the worse it can get.

Add to that mix a government and Fed trying to do things unimaginable 3 years ago and I say you have a prescription for calamity.

Your efficient market hasn't a clue what is going to happen next. read Fooled by Randomness by Taleb.

Public Library said...


Here is a great summary about the illusion we live in and how long it might last based on historical precedence.