Credit Pushing Stocks Down

The credit markets have dragged the stock marked down with them. Indeed, the stock market is in a sense a credit market itself, so this is not a big surprise. The chart above shows CDS yields for the banks. There is an obvious spike around Oct '08, then a leveling of, and another spike up.

In contrast, if we we look at manufacturing, the two humped shape is no longer apparent. However, manufacturing spreads do look a bit worse now than back in October.


In the consumer sector, the situation is slightly better, but not exactly rosy either.


In my opinion, it looks like there are possibly two factors at play. The most important one is that the banks are in bad shape. The market expects that bond holders of bank debt are likely to loose a major chunk of the principal. The second factor is simply a general worsening of economic conditions that make it more likely for any company to default.

I take a bit of comfort from the fact that volatility is substantially lower now than it was during the Oct/Nov crash.


The volatility picture suggests to me that there are fewer people now who expect stocks to decline much farther than there were back in October. This is simply because volatility goes higher as stocks go lower.

Of course, stocks can go lower still, however, I would be surprised if the administration actually allowed banks to default on their debt. If they want to get re-elected that is.

I think that there is a better probability of stocks going higher than lower from here. Having said that, there is a distinct possibility of stocks deteriorating until the situation with banks is clarified. This could take another month or two.