Thursday, August 21, 2008

The Debts of the Spenders: Credit Market Divergence


Most equity investors don't know much about the debt markets, so they aren't paying attention to this. However, debt spreads, or the difference between corporate bonds and treasuries continues to widen. In fact, these spreads are worse than they were in March following the Bear Stearns collapse. This indicates reduced risk appetite resulting in credit drying up. Every time this has happened in the past, the equity markets have corrected and caught up to what the debt markets were telling them.

Why the temporary divergence? Simple, the market is ignoring this for the time being, but it won't last for much longer. Additionally, the government cannot intervene nearly as easily in the debt markets as they can within equity markets. After all, there are only 30 stocks in the DOW Jones Index, it's very easy to buy up some big names on very bad days to even out the supply/demand imbalances.


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