The difficult analysis of the credit markets is exactly that: analysis.
In the equity markets, when a company encounters difficult times, it tends to be isolated and somewhat unique to that company. The issues can be quantified and analysis will quickly give the investors the snapshot of the current value the company will have in the market place.
Stocks are simpler in that respect. Pertinent data is somewhat easily put into categories like price to earnings ratios, price-earnings to growth ratios, cash flow yield, gross profit margins and, of course, the ultimate measuring stick -- operating margins. A publicly traded company will endorse a set of expectations for an ensuing quarter and in most cases, the whole year.
The fixed-income credit markets are a different story. The movement of bond prices is quite often a vote of confidence -- or lack of confidence. The massive credit market runs the gamut of fully secured United States Treasury paper to junk bonds. The credit-worthiness of a bond is judged and given a rating score by a third party, normally Moody's or Standard and Poor's.
The biggest issue facing investors with fixed-income instruments is the lack of consistent, hard information. The information can be spotty and not always complete. Is the pool of mortgage debt held by an institutional investor in good shape or poor shape? Is 5% of the underlying mortgage paper in jeopardy? Or is it 10%? 15%?
If the portfolio of "paper" is leveraged, meaning one dollar of equity is controlling eight dollars of debt, and the paper is "de-valued" by 15-20%, the portfolio has no equity value left. With negative equity value, the managers are forced to sell out the bonds, thus exacerbating the down side. To compound the problem even more, fixed income traders know when a fund is involved in a "fire sale" and the traders will "drill-down" the bids for the bonds even more, trying to grab them at a bargain price. It can be a vicious cycle.
If the portfolio of "paper" is leveraged, meaning one dollar of equity is controlling eight dollars of debt, and the paper is "de-valued" by 15-20%, the portfolio has no equity value left. With negative equity value, the managers are forced to sell out the bonds, thus exacerbating the down side. To compound the problem even more, fixed income traders know when a fund is involved in a "fire sale" and the traders will "drill-down" the bids for the bonds even more, trying to grab them at a bargain price. It can be a vicious cycle.
Until the credit markets settle down and stabilize, the equity markets will also suffer from the jitters.
Georges Yared is the CIO of Yared Investment Research.
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Reader Comments (Page 1 of 1)
8-07-2007 @ 6:53AM
Tom said...
The next 3-9 months ought to provide some real fireworks in the markets as ARMS reset, creative mortgage schemes get halted and credit adjustments are made. Hold on!