Interesting Read: At Quarter's End, Fears Coalesce
THESE ARE DAYS WHEN INVESTORS ARE ANXIOUSLY fixated on their margin clerk, a fellow who not long ago was so easily taken for granted. Is he in a good mood? Did he get a good night's sleep? Did he call while I was out? What does it mean that he didn't call?
For the stock market, this margin clerk is the credit market. The favorable supply/demand regime serves at the pleasure of the corporate-bond market. The bond folks are not merely the gatekeepers of the marginal dollar that can sluice into stocks as buybacks or buyouts, but are perhaps the best gauge of perceived economic risk and financial confidence.
With a handful of smallish buyout bond and loan deals having been pulled or modified last week, and financial shares sagging as a result, the stock indexes traded in an emotional and irresolute manner on the way to a flat weekly performance. An uncomfortable pattern of early rallies and steep declines was evident. Of the five days last week, all but Wednesday saw the Dow industrials drop by more than 100 points from their intraday high to the close.
The jumpy action Friday -- the Dow lost 13 but finished 115 points off its intraday high and 94 above its low -- suggests that traders have gone from anticipating Merger Mondays to bracing for a Mark-to-Market Monday.
The trendy fear of the moment is that the nastiness in subprime mortgage securities and resulting hedge-fund losses will trigger a round of markdowns of credit values generally, which would fuel fund losses, prompt sloppy liquidations, sap the appetite for corporate debt and raise borrowing costs generally.
The arrival of quarter's end helped this fear coalesce, with blogs and instant messages on the Street thick with foreboding chatter about the possible hedge-fund losses that would emerge once the quarterly books were closed (not to say cooked). And so, for the moment, the paragons of prudence are perched on the dunes, peering through binoculars in search of distress signals or even bodies that might wash up on the beach. This will be the thing to watch for the next little while, it seems.
The good news here is that there is such a widespread fear of bad news coming from the market's margin clerk. The devil we all expect usually isn't the one who shows up. Even better that the clerk seems to be in decent enough spirits, gauged by the risk spreads in corporate bonds.
Joe Mezrich, quantitative strategist at Nomura Securities, monitors the interplay of spreads on low-investment-grade corporate bonds and the market's implied forecast of stock volatility. These things have been highly correlated in recent years.
When stocks' implied volatility has shot higher while bond spreads have stayed calm -- as is the case now -- the bond market usually had it right and stocks recovered or rallied over the coming months. This script played out both in May 2006 and this past March.
For sure, if the junk-bond market gags hard on more and larger deals, high-grade spreads won't matter for stock-trader's sentiment, raising as it would a nice excuse for a deeper, fear-inducing and more cleansing selloff than we've suffered so far this year.
Some skilled tape watchers are placing heavy significance on the indexes' ability to hang above last week's low in the S&P 500, 1% below current levels, implying a thin cushion above a trap door. Yet for all the quite-valid but well-publicized fear out there, the persistence of traders embracing the bearish case continues to argue against the idea that disaster looms. Nasdaq reported last week another 9% one-month rise in short interest, which brings its five-month increase to a huge 33%.
Some technical and structural factors are certainly buoying short volumes, but that can't be all. If stocks melted down from here, it would mean the market was uncharacteristically rewarding an exceedingly popular trade.
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