Stock market vs. credit market: Which is right?
Posted
Jun 25 2009, 05:59 PM
by
Anthony Mirhaydari
Rating:
While stock investors pushed the broad market to impressive gains on Thursday, credit investors sat on the sidelines with their arms crossed. They're not interested in the "green shoots" of optimism the stock bulls are peddling. Riskier, high-yield debt sold off modestly today in a sign debt buyers are more than a little suspicious of the economic data being used to justify higher prices.
Just look at breadth. On the NYSE, advancing issues outpaced decliners by a ratio of 4.3 to 1. In the credit market, things were more mixed: Advancers outpaced decliners 2 to 1. Also, look at risk appetites. Riskier credits underperformed more defensive holdings. But for stocks, the Russell 2000 small cap index outperformed the Dow Industrials by nearly 40%.
According to WJB Capital Group strategist Brian Reynolds, this difference of opinion can best be seen by the relationship between JC Penney (JCP) and Warren Buffett's Berkshire Hathaway (BRK.A). In late April, the credit market was saying that JC Penney was six times riskier than Berkshire. The stock market had a different opinion. As a result, JC Penney's stock has doubled since March 9 while Berkshire is up just 18%.
So which is right, the credit market or the stock market? Based on the opinions of options traders, it appears the advantage goes to credit buyers.
Tim Backshall, chief strategist at Credit Derivatives Research, points out in a note to clients today that a majority of long-dated bonds sold off on the expectation of increased volatility. We can see this through what's called the "volatility term structure" -- the ratio of short-term volatility expectations to long-term expectations as determined by S&P 500 options trading in Chicago. On Thursday, for the first time since last August, the ratio dropped below 0.90 -- which is "exceptionally bearish."
Since the beginning of 2008, dips below this level have been associated with significant market tops. I've highlighted these examples in the chart above. On the other hand, jumps over the 1.05 level are often associated with bottoms like the March low.
Thus, as equity investors slowly come to the realization that all is not right with the economy -- reaching the same conclusion as their debt and options colleagues -- the major indexes will certainly come under pressure. But it could be a few days before this happens. Remember that professional money managers are trying to prop up the market to lock in profits and secure lucrative second quarter bonuses. This won't be an issue come July.
Disclosure: The author does not own or control a position in any of the funds or companies mentioned.
Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.
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