Never before have we seen the markets place so much faith in the hands of European politicians. At the start of last week, credit spreads began to tighten and the equity markets took off higher. The improvement in the markets was attributed to unsubstantiated rumours that European policymakers were close to formulating a comprehensive liquidity and recapitalisation plan.
But the rumours appear to be for nowt, as no formal news was released over the course of the week. By the end of the week, the credit market gave up the early-week gains and closed relatively unchanged. The Morningstar Corporate Bond Index ended the week at 250 basis points over Treasuries, 1 basis point wider than the previous week.
We were amazed at how much the markets had rallied on these rumours. While we fully expect that the European policymakers are working on such a plan, we were sceptical that politicians would be able to get each of the eurozone members to agree on a plan of action in such short order.
Trading volume in the credit markets was weak, perhaps suggesting that investors were not buying the hype. In fact, we heard from several sources that high-quality, short-dated corporate bonds were in demand, which suggests to us that many investors were shortening duration. We're not sure if investors are concerned that interest rates could rise or credit spreads could widen further, but either way, it had the feel that investors were looking to reduce risk.
As we have pointed out before, over the next few weeks (maybe months?) credit spreads will continue to be whipsawed by the headlines out of Europe. At these heightened levels, from a fundamental viewpoint, we think credit risk is attractive. In fact, we are beginning to find significant value in some of the more beaten-down issuers, such as those in deeply cyclical sectors.
