Wednesday, 24 September 2008

Pay Attention to the Credit Markets

Whilst it may be entertainting to watch stock prices fluctuate up and down. If you want an indication of the level of financial market stresses, it's a good idea to take notice of events playing out in the credit markets.

Yesterday Caterpillar raised $1.3 billion in a bond offering. It's a positive that they were able to get that offering away but take a look at the terms:

Caterpillar Raises $1.3 Billion in Biggest Bond Sale in 2 Weeks

The sale, Caterpillar's biggest, was split between $750 million of 6.2 percent, five-year notes that priced to yield 320 basis points more than U.S. Treasuries of similar maturity and $550 million of 7.05 percent, 10-year bonds at a spread of 325 basis points, according to data compiled by Bloomberg.

Caterpillar, the biggest maker of earthmoving equipment, last issued five-year notes on Aug. 7, selling $300 million of 4.9 percent senior unsecured debt that paid a spread of 175 basis points, Bloomberg data show.

Peoria, Illinois-based Caterpillar sold 5.45 percent, 10- year notes on March 19 with a spread of 205 basis points, Bloomberg data show.

So even for an investment grade company like Caterpillar that is posting record profits, credit is proving much tougher to get. Another measure of credit market distress is the so-called TED spread. In brief the TED spread is a measure of how willing banks are to lend money to one another. The wider the spread the higher the level of distress.

You can see above that huge spike that occurred last Thursday when the world supposedly looked into the abyss. That quickly came down on the news of the latest socialist plan from the U.S.S.A government. However, as you can see above, it has failed to return to more normalised levels.

What the above show are severe levels of distress in credit markets and an unwillingness of financial institutions to extend credit. If those persist or get worse, the equity market is in for tough times.