This weekend, in his “Current Yield” column for Barron’s, Randall Forsyth wrote the best concise explanation I’ve read for what is going on in markets now in an article entitled “Giving Credit Its Due, Finally” (subscription required – e-mail me and I’ll email you a link). He wrote:
It was as if the credit markets were selling flood insurance and betting on a perpetual drought. In the past month the credit market realized that one day it might rain again; not that there would be floods but just normal precipitation.
He talks about how credit spreads between high and low quality debt have increased dramatically.
For instance, spreads on the LCDX, an index of bank loans, have widened out to 357 basis points from only 100 basis points at the end of May – a huge increase.
The spread on a high yield bond index kept by KDP Advisors has widened to 409 basis points from 255 at the beginning of the year.
It was this rise in the cost of credit that made it impossible for Chrysler and Allianz Boots to place their debt with investors last week.
And it was mainly that that led to the 500+ plus point crash in the Dow on Thursday and Friday:
…. the math for buyout artists changed dramatically. And that resulted in the dramatic downward repricing of equities, including 500 plus Dow points Thursday and Friday.
Again, I highly recommend Ken Fisher’s Financial Times article from 2 weeks ago in which he reviewed recent stock market history demonstrating that widening credit spreads precede downturns in the stock market and vice versa (which I blogged about a couple weekends ago).