If you had been watching credit spreads you could have seen the Enron thing coming long before it happened. Now that chunks of the credit market as a whole are suffering dramatically widening spreads, what does that say?
"Brian Reynolds
Risk...
10/07/02 06:03 AM EDT
I have been writing for the last few weeks about the concerns that I've been having about the corporate sector in both the TT and my last two IRs.
Corporate spreads have continued to widen, and junk spreads are now within 20bp of their all-time wides. I am more concerned now than I was in May. We are in the economic crossroads that I have been writing about since early summer, and we are heading into the time of year when fixed income spreads normally widen and trading becomes difficult. Not only does that seasonal widening have the potential to be worse than normal, but that widening would be happening from what are now near-historical levels. I've written in the past how we'll have big problems if the corporate bond market unravels, and we are not too far from that point.
What has so many people worried is the number of managers who need a good fourth quarter – not just hedge funds and equity managers, but bond managers as well. I've written that the action in corporates this year has threatened the viability of some bond managers. We've seen some institutional client defections already, but there will probably be more after year-end. If those clients shift to better-performing managers, or if firms are forced to merge, then those issues that have done poorly this year could face additional pressure as they get dumped. If those clients decide to reduce their exposure to corporate bonds, then the normal improvement in corporates that happens at the start of a year may not materialize."
"Brian Reynolds
...and Return
10/07/02 06:06 AM EDT
Of course, I've also written that with increased risk comes an increase in potential opportunity. After July's equity plunge, I recommended that people plan how they would handle a better or worse environment. If you haven't done that yet, it's time to do so now.
Two weeks ago, after seeing some things that worried me, I cut my junk weighting (of course, in hindsight, I wished that I had cut even more). Now, junk spreads are about 60bp wider, so it's time to start thinking about where there might be opportunity.
I've mapped out a series of 10 possible adds between now and year-end that would take me to my internal position limit in junk. These are at levels that range from a little wider than current levels to meltdown levels (so I hope that I don't get to my max position). They are also a function of time; I would be more inclined to add at current (or even narrower levels) the closer we get to the middle/end of next month, when dealers tend to clear the decks for their November year-ends.
I've written that it's not necessarily a good idea to mimic me; more aggressive types might move faster then me; less aggressive types might sit it out. Hopefully, people will be able to factor what I'm seeing and thinking into their own investment mix. It's also important to remember that most of the people playing in this space take steps to hedge themselves. Some will play Treasuries (expensive as they are, Treasury prices will go up if the corporate market unravels); most will hedge their exposure through the equity market (as I will) through either puts or shorts.
For those who are thinking of playing in individual bonds, it's also important to note that the bond market is split in every way imaginable. People have been flocking to Treasuries and away from corporates. Within investment-grade, there are high-quality names trading a little over 100bp off of Treasuries and there are triple-B's trading at spreads 3-6 times or more as wide (Tyco, for example is around 900bp off, though it is technically split-rated, with some ratings at investment-grade, and some at junk, so it is still technically available for many investment-grade managers to buy). Within the junk universe, double-Bs are trading at 600bp off (300bp tighter than Tyco) while issues with a C in their rating are more than 2000bp off (yes, that is right: 20% more than Treasuries; a yield of more than 23%)." |
