The (Credit) Party We Weren’t Invited To

Today's headlines are so jam-packed with credit worries, there wasn't much else reported today. As a follow-up to yesterday's commentary (Debt Disambiguation, 07/26/07), today we provide an additional perspective on this week's market drop. Here are just a couple headline examples out of dozens we saw today:

The End of the Credit Party
By Grace Wong, CNNMoney.com
https://money.cnn.com/2007/07/27/markets/credit_deals/index.htm?postversion=2007072711

U.S. Stocks Extend Steepest Drop in 5 Months on Credit Concern
By Lynn Thomasson
https://www.bloomberg.com/apps/news?pid=20601087&sid=auCLiCveWm70&refer=home

MarketMinder readers know the financial press doesn't have a reliable filter for news. Their job is (generally) to report what's happening, not tell you what's significant. That part is the investor's job. But in today's world of spin and sensational language, it's easy to get mixed up between opinion and fact.

This week has been a classic example. Garish terms like "endless credit" and "credit party" get bandied about, but these are merely sensational descriptors. (Was there really a credit party? How come we never get invited to these things? We wonder what Henry Kravis wore. Not another one of those stuffy gray pinstriped Armani suits, we hope! It's a party after all…loosen up a little!) And for that matter, what difference does it make if this is the steepest stock drop in five months anyway? Who cares?

Market "jitters" and sharp, sudden spikes in negative volatility usually (almost always) mean minor dips and corrections, not a new bear market. We see this as an emotionally-based sentiment shift in reaction to a minor event relative to the broader economy. Today's predominant investor attitude seems to be "it's too much too fast for all this high yield debt, and the economy will suffer." The fundamentals, however, don't seem to jibe.

Corporate balance sheets are still extremely strong. Net corporate debt as a percentage of profits is under 3.5x, near an all-time low. This is not a situation where the corporate economy is super-leveraged and all it takes is one last straw to break the camel's back. What's more, US corporations are generating record amounts of cash. As we stated yesterday, the spread on AAA bonds and 10-year Treasuries is still a mere 0.7%! That spread is based on a very low nominal rate—10-year Treasuries are below 4.8%.

With the exception of the Bear Stearns subprime hedge fund debacle, there have been no major corporate defaults. (And keep in mind, Bear Stearns itself is just fine, thank you very much. Only a couple highly leveraged hedge funds imploded.) Few recognize we're currently in a period of unusually low defaults for banks and financial institutions. This is a time of nearly unparalleled financial stability in the developed world.

The big hubbub is mostly pinned on a few instances of shelved high profile new debt issuances. Though we dealt with this issue in yesterday's commentary, we're compelled to reiterate that even if higher rates on high yield (that is, very risky) debt are heading up for good—that surely would be a bad thing for the private equity boom, but doesn't necessarily mean much tied to the broader economy.

Remember, high yield rates are approaching something more like normalcy from an extended period of very low rates. From "low" to "normal" is not the stuff of catastrophe.

Market action this week is looking more and more like textbook T.G.H. (The Great Humiliator) material. To abandon your bullishness now, while people are afraid and the facts don't corroborate the fears, is folly.

Really, we're not bitter we weren't invited to the credit party. We're just bullish.

Have a great weekend.

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Source: GaveKal Research