{"id":22840,"date":"2008-04-21T17:14:00","date_gmt":"2008-04-21T17:14:00","guid":{"rendered":"https:\/\/clusterfamilyoffice.com\/blog\/?p=520"},"modified":"2008-04-21T17:14:00","modified_gmt":"2008-04-21T17:14:00","slug":"la-quimica-inestable-de-la-molecula-economica","status":"publish","type":"post","link":"https:\/\/clusterfamilyoffice.com\/en\/la-quimica-inestable-de-la-molecula-economica\/","title":{"rendered":"The unstable chemistry of the economic molecule."},"content":{"rendered":"

\"\"<\/a><\/p>\n

As we can see from the chart above, from the always interesting blog by Investorsconundrum<\/a> and compiled by Bank of America, the current spread for the CDX<\/a> IG (North American credit default swap) on which debt issues are quoted with investment grade<\/span> Compared to the official interest rate \u2013 that is, one carrying zero risk of default \u2013 it is extremely high. So far, this is relatively understandable given the mistrust surrounding this type of fixed-income asset and the illiquidity of that market. But what is truly astonishing is that, as can be seen in the chart, these spread levels should correspond to much lower equity market levels. Specifically, the chart shows the S&P 500 index, which has historically traded well below 1,000 points when bond spread levels (CDX NA IG Index Spread) have reached 150 bps.<\/p>\n

Over the last nine months, coinciding with the global credit crisis, this historically stable relationship between the debt spread and the stock markets has been shattered in a way never seen before.<\/span> For this reason, and for other reasons, we have been warning for months that we are making economic history. What is happening now is being mistakenly compared to the crash of 1929. It is very different. And I would go so far as to say that it is far more significant.<\/p>\n

Let\u2019s explain and analyse in detail what we have said so far:<\/p>\n

\"\"<\/a>The spread at which the yield on a bond issue is quoted is the difference that a company (or government) must pay above the official interest rate to make the debt it intends to place with investors attractive enough to sell. Logically, the greater the confidence in that company, the smaller the spread over the official rate it will have to pay investors for them to lend their money in exchange for these promissory notes, bonds, etc. Obviously, the lower the confidence, the higher the spread will soar. At present, this spread has reached extremely high levels due to the mistrust that has prevailed since last summer. Consequently, credit default swaps (CDSs) \u2013 whose index is shown in the chart above \u2013 are becoming proportionally more expensive. You can compare this with the chart on the right, which shows the spread over the 5-year US Treasury yield as it stood in 2004. Furthermore, the market is currently so tight that spreads may occur in the debt prices themselves between bid<\/span> y ask<\/span> (supply and demand) that are truly out of this world.<\/p>\n

What the graph and logic tell us is that there has always been a link between confidence in \u2013 or mistrust of \u2013 the debt issued by a company, and investors\u2019 confidence in \u2013 or mistrust of \u2013 the share price of those companies on the stock market. In other words, The greater the confidence in corporate debt, the narrower the spread over the official rate, the lower the CDX and the higher the stock market price of its securities. And vice versa. This is entirely rational and, to date, a universal law of modern economics.<\/span> Well then,<\/span> Ever since the so-called credit crisis broke out, this logical relationship has ceased to exist. <\/span><\/p>\n

Today we see that mistrust in corporate debt with<\/span> investment grade<\/span> It is enormous and, as a result, its spreads and hedging costs are outrageous. Nevertheless, the share prices of these companies \u2013 which retain their credit ratings almost intact (an irrelevant paradox given the lack of credibility of the rating agencies in recent times) \u2013 remain at levels far removed from any sense of mistrust, even though opportunities are now emerging. value<\/span>. In other words, stock market investors continue to have confidence in their shares but, paradoxically, not in their debt! Illogical, yes. Unstable, too.<\/p>\n

\"\"<\/a>This scenario will therefore undoubtedly seek to stabilise over the coming months, just as any chemical bond does along its molecular path. The million-dollar question is on which side it will stabilise: Confidence in corporate debt may be restored, leading to a narrowing of current spreads and a rise in the current price of fixed-income securities; or confidence in listed equities may be lost, in which case we would see capital losses in equities, as predicted last week Goldman Sachs on the S&P 500<\/a>.<\/p>\n

\"\"<\/a>Personally, I believe that the first option is more feasible \u2013 and, of course, preferable \u2013 (if I may say so, analysts at Goldman Sachs). Because following the bursting of the property and credit bubble, It seems that the equity markets have been seen as a kind of safe haven for investors,<\/span> Although I am surprised myself by what I have just said. Given the surprising resilience that the stock market seems to have in the face of prevailing mistrust, stabilisation could well come about through a recovery in confidence in investment-grade corporate debt, as the fundamentals of non-financial companies remain solid at present. As for financial firms, their fundamentals may already be largely priced in, via current share prices, earnings reports and provisions set aside for losses in future financial years. This would dispel the spectre of a deepening bear market that began in the equity markets almost a year ago, restore confidence, and, of course, in turn stabilise the chart shown in the header, bringing spreads down to reasonable levels. In fact, it is already slightly above 100 today, although the volatility of these indices continues to break records.<\/p>\n

It seems clear to me that there is a great reverse flow in search of safe wells<\/a>, which is in disarray and tied up in bank deposits. It is true that other capital flows have ventured into speculative markets for commodities, foreign exchange or alternative investments, but it seems clear that there is great investment potential traditional<\/span> waiting to be channelled (currently into deposits and AAA-rated sovereign debt) as soon as confidence in the system is restored. I would even go so far as to say that this mistrust may already be largely priced in, with the exception of mistrust in equities which, as we have already explained, could stem from poor corporate results that would also stabilise the current situation through falls in the stock markets; in which case, fixed-income spreads investment grade<\/span> They would continue to break records over time, leading to a global crisis on an unprecedented scale.<\/p>\n

\"\"<\/a>In summary, we could envisage the system stabilising under two very different scenarios: one based on trust and the other on mistrust. <\/span>In the first scenario, the spread on investment-grade government bonds would narrow, and equities could remain flat or even start to rise rallies<\/span> thanks to the latent flows mentioned. In the second scenario, however, the RF would remain severely battered and, in the coming months, we would see very poor results from large companies, dragged down by dire recessionary macroeconomic figures. This would lead to very sharp stock market falls, at least in the developed world. Emerging markets, however, might be less affected, or even unaffected altogether.<\/p>\n

However, we should bear in mind that when market reactions seem obvious, there is always a black swan<\/a> which exposes those who lack humility\u2026<\/span><\/p>\n

In short, we envisage two opposing scenarios, but both would stabilise the aberrant imbalance currently affecting the RF and the RV: trust and mistrust. What we consider unfeasible is for the current situation to drag on, because it is unstable<\/span>. And the tendency to seek stability, as in molecular chemistry, should be a law that is difficult to ignore in the medium and long term. As I said in a comment on this<\/a> an interesting article by Cretan<\/a>:<\/p>\n

\"\"<\/a>There is debate as to whether there will be deflation or hyperinflation, stabilisation driven by confidence or mistrust, and so on\u2026 but we will not remain on this unstable ground for much longer.<\/p>\n

Never before has the economy been so global and so closely linked to Yin and Yang.
<\/span><\/p><\/blockquote>\n

Don\u2019t you think so?<\/div>","protected":false},"excerpt":{"rendered":"

Seg\u00fan podemos ver en el gr\u00e1fico anterior, del siempre interesante blog de Investorsconundrum y elaborado por Bank of America, el spread existente para el CDX IG (Credit Default swap norteam\u00e9rica) al que cotizan las emisiones de deuda con grado de inversi\u00f3n respecto al tipo oficial del dinero, es decir riesgo de insolvencia cero, es elevad\u00edsimo. […]<\/p>\n","protected":false},"author":6,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[20],"tags":[],"class_list":["post-22840","post","type-post","status-publish","format-standard","hentry","category-sin-categorizar"],"_links":{"self":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts\/22840","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/users\/6"}],"replies":[{"embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/comments?post=22840"}],"version-history":[{"count":0,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts\/22840\/revisions"}],"wp:attachment":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/media?parent=22840"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/categories?post=22840"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/tags?post=22840"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}