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Prieur Perspective: Out of the Woods?


Investors seem to be shrugging off housing woes.


The last week was characterized by investors increasingly taking the view that the worst of the credit crisis was over. They seemed to be shrugging off further substantiation of the dreadful state of the U.S. housing situation as they digested the latest round of quarterly earnings reports. The latter ranged from plunging profits from Bank of America (BAC) to a dreadful report from Ambac (ABC) to guidance from Microsoft (MSFT) that failed to live up to investors' expectations.

Stock markets see-sawed as investors assimilated the various economic and earnings reports, with the S&P 500 Index eventually eking out a positive return of 0.5% for the week, thereby consolidating the previous week's gains (+4.3%).

Evidence of a more relaxed undertone among equity investors was confirmed by the Volatility Index (VIX) falling to its lowest level of the year and below the psychological 20 barrier, i.e. the level that had set the ceiling for fear until the credit crunch began in July 2008. See below.

The real action, however, was in the government bond markets where prices plunged (i.e. yields jumped) as investors were spooked by lifetime-high oil prices, stoking inflation pressures (see graph alongside of the price of the 10-year US Treasury Note). Furthermore, safe-haven considerations, which were dominant for most of the duration of the credit crisis, took a back seat on the prospect of a better U.S. economy ahead.

Click to enlarge either chart

A word of caution, however, came from John Hussman (Hussman Funds) who said: "Aside from short-term speculative pressures (largely driven by relief about Bear Stearns (BSC) ), nothing in recent data suggests a material abatement of recession risk, mortgage risk, profit margin risk, or dollar risk."


Last week saw only a handful of economic reports, showing further declines in the housing market, better-than-expected news for weekly initial jobless claims and durable orders, excluding transportation, and another depressed consumer sentiment reading coming in at a 26-year low.

Asha Bangalore of Northern Trust said:

"Although the National Bureau of Economic Research has yet to announce that a recession is under way, incoming data strongly suggest that the economy is in recession. The more important questions now are about the depth and duration of the recession and what the nature of the recovery process is. In terms of duration, the recession could be close to the average post-war recession of 10 months, but the severe credit crunch that is hampering the smooth functioning of financial markets supports forecasts of a prolonged and sluggish recovery."

As far as Wednesday's interest rate announcement by the FOMC is concerned, the graph below indicates that the Fed fund futures see a 70% chance of a 25 basis point rate cut from 2.25% to 2.0% (green line) and a 25% chance of no rate cut (orange line). One month ago, the futures saw an 88% chance of a 50 basis point cut; one week ago it was a 46% chance. Now the futures see only a 5% chance of a 50 basis point cut. This serves as confirmation of how market participants' apprehension about the credit crisis has lessened.

Click to enlarge

Source: Paul Kedrosky, Infectious Greed, April 24, 2008.

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