A differing View

I'm more than happy to entertain those whose views differ from mine so long as they are somewhat grounded in reality and accruedinterest has a great post today explaining how we've probably seen the last of the large swings and width of spreads.

Its against my programming to call bottoms

Friday's discussion on bearish market sentiment was really great. Thanks for all who commented.

Most of the comments seemed to focus on stock prices. As a bond pro, I spend my time thinking more about yield spreads, both in credit and other sectors. As discussed many times (many, many, many times), there were two elements causing spreads to widen: poor liquidity and weaker economics.

Liquidity has improved dramatically since the Bear Stearns bailout. The feeling is totally different than in some of the other false rallies (in credit) we've experienced since September. Previously, any hiccup would cause spreads to move drastically wider. There were times when we moved a bit tighter, then some writedown would be announced, and it would all go to hell again. It isn't as though we haven't had hiccups the last couple weeks. The 200 point sell-off on GE's earnings is an example (I wrote about this here). Or Wachovia's need for more cash. Or Bank of America's weak earnings report. Now these events are taken in stride. Spreads have moved wider on certain days, but its controlled, more reasonable. Not panicky. I won't say that spreads (especially in CDS) aren't still volatile. The massive amount of shorts in CDS that have been or are being covered is seeing to that.

Plus the correlation of spreads has broken down. Now it isn't necessarily true that agency debt, MBS, and credit all move the same direction on any given day. Hell municipals had become highly correlated with credit spreads. Now it seems that these spreads are moving on their own supply and demand conditions, not on liquidity fear.

So am I calling a bottom? Well, I don't really invest that way, so if I didn't have a blog, I wouldn't really think about a "bottom" very much. I try to stick to fundamentals and spend only a little time on technicals. Liquidity is part of any fundamental analysis of a bond, so indeed it became tough to value many different bonds in recent months. And deep fundamental investors tend to be a little early, seeing the fundamentals shift and/or pricing (un)attractive before the market actually shifts.

But yeah, if you stick a gun to my head, I'd say we've seen the wides in credit spreads. Not because the economic problems are solved, but because liquidity has improved to the point that people are willing to be opportunistic. That will put a lid on how far investment-grade names will move before yield hungry investors come in. Issuers will be able to come to market with new issues, and the wheels of the credit market will continue to churn.

I personally think he may be right for the next couple quarters, however liquidity is a coward and when the economy as a whole starts to deteriorate I do believe we'll find far less people willing to "be opportunistic". I think that we are more in a wait and see approach an the bond market reflects this.