Tuesday, June 2, 2009

Bull Bull Bull...Fool Fool Fool?

Everyone believes a bull market is running on the track; everyone believes a recovery is running on the track.

Consumer Confidence shoots up high; crude oil price and BDI hits recent new high; PMI is improving. Everything but the jobless claim sounds less profounding.

This is a trap.

A way to view the economy and the stock market is the business activity - by the banks, SMEs, and corporates.

Lets start from banks.

The followings are rates by FED and banks (by bloomberg):
1. 30 year fixed mortgage 5.32% > 4.94% (1 month prior) and 5.25% (3 months prior)
2. 1-year ARM 4.53% <> 2.76% (1 month prior) and 2.71% (3 months prior)
4. 1-year CD 1.87% < 2.01% (1 month prior) and 2.17% (3 months prior)

The spreads are as follows:
1. 30 year: 255pts (present); 218pts (1 month prior); 254pts (3 months prior)
2. 1 year: 266pts (present); 327pts (1 month prior); 306pts (3 months prior)

By practice, applicants for 30 year fixed mortgage have better credit ratings and financial strength than those for 1 year ARM. Setting aside the issues "Wall Street and Main Street guru lost hips and can no longer afford luxuries", such rising, comparing with huge decrease on 1-year ARM, is still abnormal. In other words, banks encourage people with higher probability of delinquency to borrow and discourage people with better abilities to pay.

How about the commercial loans on the other hand?

Instead of using LIBOR as a metric stick, banks are using Treasuries rates plus risk premium to evaluate, mainly due to the fact that the most availably "reliable" asset is the paper printed by FED. So lets take a look on the treasuries rates quoted today (by bloomberg):
3-month: 0.11%; 12-month: 0.44%; 2-year: 0.95%; 10-year: 3.66%; 30-year: 4.52%

Normally the risk permium will be somewhere around 150pts. The bank will usually on top ask for another 50pts as their own profits (and commissions to the CRM). So, lets take it as 200pts. Now the bank will not use the short-term rate to grant a loan. The prime rate is at 3.25%, and most likely it will use the 10-year or 30-year rate, depending on the credit rating, to loan to the clients. Therefore, they will ask for the range 5.66% - 6.52%.

What is the benchmark investment grade corporate bond rate recently? 6.06%

Apparently for the corporate that can afford the adhered charges, issuing their bonds for sales is even more attractive than the bank rate. On the other hand, for the companies that cannot afford or too small to be eligible to borrow from open market, the bank will certainly charge the premium higher than 6.52%. In either case, small to medium size business cannot get the loans it needs.

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