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Praying For A Bottom


Credit, equity market at odds over turnaround.

Greetings from Vail, CO where the winds of deflation have yet to appear, and the word hyperinflation fails to do justice to prices of everything from bottled water to kids' ski school. Does it mean locals are all the wealthier for it? Not according to them at least, but the tourists sure leave town a whole lot poorer.

With one ear on the markets and two eyes on the snow report, I can't claim much of a pulse on the trading action, but I thought I'd chime in on the "THE" bottom vs. "A" bottom debate.

Post the Bear Stern (BSC) implosion and the Federal Reserve intervention in all things "credit", the sign posts of whether it is indeed sufficient for the government to monetize bad debts in order to make good on six years of reckless lending are at best mixed. Yes, Credit Default Swaps, or CDS, spreads on many issuers have tightened -- some meaningfully -- but many are still wider than they were a modest month ago.

Away from banks and brokers, where the heavy hand of Uncle Sam has been most prominent, things are hardly better. In the leisure and REITs area for example, where large amount of debt resides, the retracements have been marginal, and even for companies involved in mundane consumer products, we are a long way from normalcy, if the latter is defined by the environment of just 12 months ago.

Furthermore, one cannot judge the improvement in the CDS market without considering the following: buyers of these derivatives are showing five to 15 "baggers" in many of these names, and when it comes to the financial sector, it's become abundantly clear that the Fed will not tolerate defaults: wouldn't you take profits, especially considering these instruments are rather illiquid?

It's also true that the liquidity in the Fannie (FNM) and Freddie (FRE) mortgage markets is improving but isn't that axiomatic with the fact that various agencies of the federal government are "the", if not "the only" lender left standing?

These suspect rays of hope, combined with the seemingly incessant desire of investors to will a bottom in the equity markets, mask the harsh reality of what continues to happen in the corporate bond market, which is a methodical disintegration. From the a picture is worth a thousand words," this is the number of corporate issues trading at distressed levels, defined as 1000 basis points (10%) above the corresponding treasuries. Perhaps, things can't get any worse, but they certainly do not seem to be getting any better, despite the rally in the equity markets.

Furthermore, riddle me this: if efforts by the federal government to all but nationalize the largest portion of the credit markets are the cure-all for what ails them, are we now saying that socialism is the bedrock for healthy and prosperous capital markets? And if not long ago the debt markets feared that large current account deficits would "crowd out" private borrowings, what might the consequences be of a government determined to effectively supplant the private credit markets by exercising its power to print money at will?

As Toddo so eloquently stated yesterday, the Great Depression was a process, not an event. To view the collapse of BSC as the moment that priced-in the current upheaval in the credit markets may make for a good sound bite, but only until one realizes that what happened in the wake of the BSC wipe-out was precisely to avoid at all costs the pricing-in of the current problems.

Away from areas manipulated by the government, corporate bond traders seem keenly aware of this dynamic, and if they are correct in their assessment, the equity markets may be far far away from "A" bottom, let alone "THE" bottom.
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