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Four Things You Need to Know: An Overbearing Mother; Credit Default Swaps; Commercial Mortgage Backed Securities; Freaky Dollar Momentum


What you need to know (and what it means)!


1. An Overbearing Mother

Mother Morgan is turning cautious, and I am not talking about the historically gloomy Stephen Roach.

  • Chief Strategist and steadfast bull Henry McVey has increased his Bear Case probability from 20% to 30%, by subtracting from the Bull Case scenario.
  • He has also toned down his EPS estimate for the S&P 500 (3% growth) to well below consensus, and sees maximum upside of 1525.
  • Meanwhile, economist Richard Berner pins his hopes for avoiding a recession on continued strong job and wage growth. Reading between the lines, if the latter doers not come through we've got a problem.
  • Not to be left behind, Stephen Roach doesn't buy the growing chorus that the world can keep humming along if the U.S. goes into a recession. This is nothing new to the Doom and Gloom crowd, but it is somewhat surprising coming from some of Hoofy's best friends.

2. Credit Default Swaps

To keep things fair and balanced, as much as I am genetically capable of, the all important Credit Default Swap market, where credit insurance on trillions of dollars of debt can be had for the financial equivalent of a "$1 meal," seems to be shaking off its recent jitters, with spreads coming in across the credit spectrum.

  • Cheap insurance = more leverage opportunities = more LBO's / M&A = higher equity prices.
  • I remain unconvinced of the validity of such logic, but for now stock prices have agreed with its conclusion so Boo needs to be respectful.
  • See the following charts:

3. Commercial Mortgage Backed Securities

The same can't be said of the spreads in the Commercial Mortgage Backed Securities (CMBS), where REIT's go to tap the debt to fuel their monopoly game.

  • Spreads are holding their recent meaningful widening, and at the low end of the curve – the area closest to REIT's in the capital structure – they are actually getting worse.
  • This, IMHO, is the reason why the proxy iShares REIT Index (IYR) looks to be in serious need for some anti-depressant.
  • Hoofy would argue that most of the damage is taking place in the CMBS derivatives, and that the actual "bonds" are doing just fine (at least according to Morgan Stanley's data).
  • Boo counters that the same dynamic took place in the residential mortgage market and we now know how well that's working out.

4. Freaky Dollar Momentum

Before this morning's inflation data, the dollar's slide was picking up steam especially against the Euro.

  • We know that for U.S. investors a weaker dollar might help nominal equity prices, unless – that is - things in the currency markets get "freaky."
  • Quantifying "freaky" is difficult, but historically when the Dollar Index (DXY) 10-day Rate of Change goes below the -2 level, the equity markets have considered that to be "freaky."

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