Friday, August 17, 2007

The sky isn't falling ... yet.

It's been said that pictures say a thousand words. I believe that these pictures give a fairly accurate assessment of what has been happening in the markets.

I have included graphs of the Credit Default Index spreads (CDX) from Markit and the yield spreads from Merrill Lynch for Emerging Market, High Yield, and Investment Grade bonds, respectively.

This information is available at:
and (free registration required).

Fear permeates this market. On Thursday it spread to Emerging Markets, seemingly because holders of those securities needed to meet margin calls, investor redemptions, or genuinely fear risk - of any kind!

These graphs only go back over relatively short periods of time, so the levels that we are now experiencing appear to be unprecedented. The Markit data shows less than four months, and Merrill's data goes back only two years. If more data were available (to me), it would be clear that we are seeing a return to normalcy in the pricing of risk.

Another measure of the price of risk is the VIX index (^vix;range=my;
). Yahoo has seventeen years of data on the VIX, giving a better perspective. This data, as presented in the graph, shows that this measure of risk is getting into the range that was experienced around the first Persian Gulf War, the Asian problems in '97, LTCM, the days of the day traders, and 9/11. This risk measure, therefore, seems to support the idea that we are returning to normalcy.

Whether the repricing of risk will stop within "normal" bounds is unclear. It is possible, as some in the media have speculated, that we've hit a bottom in the stock market. Personally, I doubt it.
I will write more about these issues in the near future, but there are definitely buying opportunities out there. All corporate securities are being thrown out as investors run for the exits (and government securities). It is particularly interesting that investment grade corporate spreads have increased by approximately 30% since June (a significant increase over the experience of the last few years).

More later.

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