Credit Crisis Watch: Update – Improvement in Financial Stress Index

Friday, May 29th, 2009

I have often reported on the progress that has been made on the credit front and concluded as follows in my “Credit Crisis Review” of a few days ago: “Most indications are that the credit market tide has turned on the back of the massive reflation efforts orchestrated by central banks worldwide and that the credit system has started thawing.

“However, although the convalescence process seems to be well on track, it still has a way to go before confidence in the world’s financial system returns to more ‘normal’ levels, liquidity starts to flow freely again, and the economic recovery can commence.”

Further confirmation that the various central bank liquidity facilities and capital injections are having the desired effect of unclogging credit markets comes from Goldman Sachs’s Financial Stress Index (FSI). This index includes four factors related to the degree of impairment of financial markets: counterparty risk (US dollar 3-month LIBOR-OIS), liquidity risk (MBS to treasury repo differentials), refunding risk (commercial paper outstanding) and broader risk aversion (percentage of monies held in money-market mutual funds in relation to equity market capitalization).

As shown in the graph below, the FSI is now at the lowest level on a cyclically adjusted basis since the beginning of the credit crisis in August 2007.

“… the distress premium across assets has almost completely eroded. While the recent improvement [in the FSI] is largely due to the increase in risk appetite, indicated by money-market mutual fund outflows, there has also been improvement in other metrics as well,” said the Goldman team.

Source: Goldman Sachs - Strategy Matters, May 15, 2009.

Tags: 3 Month Libor, Adjusted Basis, Capital Injections, Central Banks, Convalescence, Credit Crisis, Credit Markets, Differentials, Economic Recovery, Financial Stress, Goldman Sachs, Liquidity Risk, Market Capitalization, Money Market Mutual Fund, Money Market Mutual Funds, Risk Appetite, Risk Aversion, Strategy Matters, Stress Index, Team Source
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Signs The Economy is Stabilizing

Wednesday, April 15th, 2009

The global economy appears to be stabilizing according to a research report by the Goldman Sachs Global Economics team. To monitor whether economic data are indeed improving they have developed a simple diffusion index, recording whether a particular data series has increased or decreased relative to its previous reading. Thirty-four monthly economic data points from the US, Europe, China, Japan, Brazil, Russia, Korea and India are analysed, including manufacturing and non-manufacturing surveys, consumer confidence indices, industrial production, retail sales, jobless claims, housing data and some credit-related data.

After having languished below 50 since the spring of 2007, the Diffusion Index increased above 50 in February and March (March doesn’t yet contain all 34 indicators, though). Any reading between 0 and 50 indicates the data are deteriorating, whereas above 50 implies improvement.

When looking regionally, the economists believe the worst of the cycle has been seen in the US and the UK, but this does nor appear to be the case in Euroland and Japan.

The team concludes: “Some of our other proprietary indices are picking up. Our Global Leading Indicator has improved in March and momentum has been improving for the last three months. Our Financial Stress Indicator also improved. If these signs of improvement really set in we should expect:

• stronger performance from equities;
• cyclical sectors to outperform;
• softer performance from government bonds;
• strong outperformance of equities versus bonds, and
• higher commodity returns, particularly industrial metals (copper).”

Source: Binit Patel and Kamakshya Trivedi, Goldman Sachs - Global Economics Weekly, April 8, 2009.

Tags: China Japan, Commodity, Consumer Confidence, Diffusion Index, Economic Data, Economics Team, Economists, Emerging Markets, Euroland, Financial Stress, Global Economics, Global Economy, Goldman Sachs, Government Bonds, India, Industrial Metals, Jobless Claims, Leading Indicator, Outperformance, Retail Sales, Simple Diffusion, Trivedi
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Yale’s Swensen: “Extraordinary Opportunities in Distressed Debt

Monday, January 5th, 2009

Legendary Yale University Endowment investor, David Swensen, says there are extraordinary investment opportunities in the credit world and is “pursuing a recovery” by acquiring distressed debt.

Bloomberg says:

“There are some really extraordinary opportunities in the credit world,” said David Swensen, the school’s investment chief, in a phone interview from his office at the New Haven, Connecticut, university. “Everything, from bank loans to investment-grade bonds to less-than-investment grade bonds, is priced at really extraordinarily cheap levels.”

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Among Swensen’s core principles identified in “Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment” (Free Press, 408 pages, $35) is the importance of diversifying holdings while focusing on equities. In a recession, the advantages of diversification get overwhelmed by investors’ selling equities in favor of U.S. Treasury bonds in a “flight to quality,” he said.

“When you have a market in which any type of equity exposure is being punished, it’s going to hurt long-term investors,” he said.

In the current environment, distressed corporate securities can produce “equity-like” returns, Swensen said.

“You want to make sure you’re with companies that have the ability to survive in a really tough economic environment” he said, declining to name any of the companies.

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Until financial institutions resume lending, the economy will remain stagnant, Swensen said.

“I don’t think the Fed or the administration has figured out how to fix credit markets,” he said. “We are going to experience economic and financial stress as long as the credit markets are broken and it’s not until we start seeing the credit markets functioning properly will we be able to see a path to economic recovery.”

Swensen advocates federal guarantees for deposits in money- market funds as a way to encourage investment in the vehicles that buy corporate debt.

Source: Bloomberg.com, January 2, 2009

Tags: Advantages Of Diversification, Bank Loans, Connecticut University, Corporate Securities, Credit Markets, David Swensen, Distressed Debt, Equity Exposure, ETF, Federal Guarantees, Financial Stress, Institutional Investment, Investment Grade Bonds, Money Market Funds, New Haven Connecticut, Term Investors, U S Treasury, U S Treasury Bonds, Unconventional Approach, University Endowment, Yale Endowment, Yale University
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