Broad-based Rally Across Risk?

First of all some good news the launch date of our structured credit fund has been set for the 8th of June. The primary focus of our particular fund is going to be CDOs, fins, corps and CLOs. In the current environment leveraged loans have become a very interesting asset class as the race goes on to wring value from these heavily discounted structures. As I’ve repeated ever since the earliest Zws; there can be no hope of a sustainable broad-based rally unless there is a recovery in credit; its the one reason why the Anglo-American economies, with their sophisticated credit markets, are the ones who make or break rallies. 

Nouriel Roubini has claimed that we haven’t even begun to see the recession bottom out; a more reasonable expectation is toward the end of the year. However I would argue that recovery and recession are not necessarily a strict dichotomy, different sectors are experiencing different recovery patterns. I would argue, that at least from the British perspective, real estate is already seeing a glimmer of positive growth; at least in the core of London. 

The corporate infrastructure is being rebuilt; this week alone $5bn of new issuances has been the highest for 2009. This could potentially avert corporate defaults on the basis of illiquidity; now it’ll merely be on the basis of un-profitability and that’s also unclear with government backing to avert bankruptcies. Its fascinating how recovery emerges in a piecemeal and almost unrecognisable fashion; perhaps that’s what will make it all the more sustainable?

Tone continues to remain positive, indeed even after S&P deemed it fit to place the UK on rating negative watch, sterling credit rallied in after a momentary pause and even sterling shrugged off the bad news to strengthen even further. The Rating Agencies have really done such a poor job in this credit crisis, while their acquiescence was needed during the massive issuance of structured credit products (AAA with just 2% credit enhancement anyone?), I think attempting or pretending to be vigilant now by taking action against a sovereign nation’s rating is poor judgement. With the US, UK and most of Western Europe issuing money and heavily in debt, there is no question that their AAA rating is no longer warranted, but given the fact they are the lenders of the last resort and the fiscal steps they have taken, the RA’s must back off from taking drastic measures like taking their rating down a notch or two. While investors probably realise that this sovereign risk is not AAA risk, the hit in confidence if such a formal step was taken would, I fear, be a massive setback for a market on a fragile recovery.

Speaking of fragile confidence, money markets continues to bear good news, LIBOR rates are still close to all time lows and forward LIBOR-OIS spreads continue to narrow. Asset backed commercial paper, ground zero of the credit crisis, continues to see an up tick in activity and spreads grinding in tighter. The fact that access to the debt market is coming back (at least to financial firms and corporates) is good news, if not surprising given the sort of funding we have seen Governments and Central Bank put in to balance the economy. The challenge will be for the market to get off the artificial respirator and keep the momentum going, especially considering the weakness of forecasted economic growth going forward and lack of risk appetite.