The Economist scolds the world's investors for suffering from irrational pessimism:
Economist.com: SOME six years ago, Alan Greenspan, the chairman of America’s Federal Reserve, accused investors of “irrational exuberance” in propelling the stockmarket to unjustified heights. Now the same investors are asking whether the same markets are suffering from irrational gloom. While investors have plenty to be glum about—insipid company profits, slowing economic growth, a rising risk of defaults among bonds and loans, and even the prospect of war—it has been tempting of late to conclude that the markets have lost their sense of proportion.
How else to explain the gyrations in the prices of shares and bonds issued by Ford Motor Company? Not only were its five-year bonds quoted this week at 89% of their face value but traders marked them down to the point where they were quoted as “junk”—ie, non-investment grade. This was despite reassurances from Moody’s and Standard & Poor’s, two rating agencies, that they had no plans to downgrade the company’s debt to below investment grade. True, Ford has suffered—as have its rivals, General Motors and DaimlerChrysler—from the price war that has dominated the lives of American car makers in recent months. True, too, Ford has $22 billion of outstanding secured debt that it will need to roll over during the next year—a mouthful even for America’s deep debt markets, especially in their current state. Yet neither problem on the face of it justifies the hammering that Ford’s shares and bonds have recently received.
Behind the treatment meted out to Ford, and to other companies in a similar plight, is the pessimism in the credit markets. The average junk bond is now trading at about a thousand basis points (hundredths of a percentage point) above the US Treasury bond of a similar maturity, says Bear Stearns, an investment bank. While $43 billion-worth of new bonds of speculative grade have been issued so far this year, more than twice that amount has been downgraded from investment grade to junk because of worries over the issuers’ ability to pay their way. This is unsettling investors...
My reaction is a, "Huh?" American equities are still selling for remarkably high price-earnings ratios. I take it that the Economist believes that Ford's bonds are a strong buy--that Ford Motor has a bright future filled with lots of cash flow. As an owner of a Ford car, I assure you that there is substantial reason to disagree.
Irrational gloom?
From The Economist Global Agenda
Pessimism in international credit markets is unsettling equity investors, and vice versa. Neither market has any ready answers or yet knows which way to turn
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SOME six years ago, Alan Greenspan, the chairman of America’s Federal Reserve, accused investors of “irrational exuberance” in propelling the stockmarket to unjustified heights. Now the same investors are asking whether the same markets are suffering from irrational gloom. While investors have plenty to be glum about—insipid company profits, slowing economic growth, a rising risk of defaults among bonds and loans, and even the prospect of war—it has been tempting of late to conclude that the markets have lost their sense of proportion.
How else to explain the gyrations in the prices of shares and bonds issued by Ford Motor Company? Not only were its five-year bonds quoted this week at 89% of their face value but traders marked them down to the point where they were quoted as “junk”—ie, non-investment grade. This was despite reassurances from Moody’s and Standard & Poor’s, two rating agencies, that they had no plans to downgrade the company’s debt to below investment grade. True, Ford has suffered—as have its rivals, General Motors and DaimlerChrysler—from the price war that has dominated the lives of American car makers in recent months. True, too, Ford has $22 billion of outstanding secured debt that it will need to roll over during the next year—a mouthful even for America’s deep debt markets, especially in their current state. Yet neither problem on the face of it justifies the hammering that Ford’s shares and bonds have recently received.
Behind the treatment meted out to Ford, and to other companies in a similar plight, is the pessimism in the credit markets. The average junk bond is now trading at about a thousand basis points (hundredths of a percentage point) above the US Treasury bond of a similar maturity, says Bear Stearns, an investment bank. While $43 billion-worth of new bonds of speculative grade have been issued so far this year, more than twice that amount has been downgraded from investment grade to junk because of worries over the issuers’ ability to pay their way. This is unsettling investors.
So far this year, there have been 50 so-called fallen angels—companies with investment-grade bonds that have been downgraded to junk—only seven short of last year’s total. Indeed, the total number of defaults in the corporate bond market as a whole, investment grade as well as junk, has reached a record of $140 billion; that is already more than the total amount for the whole of 2001.
While the rate of default, at nearly 9% of corporate bonds outstanding, is still below the peak of 12% seen during the recession of 1990-91 (and, thankfully, a long way below that of the 1930s), it has nonetheless added to the sense of gloom. Making matters worse is the fact that it is not just companies with junk bonds (ie, those most at risk) that have been defaulting. Worryingly, a growing number of companies with investment-grade bonds—among them Enron, WorldCom, Swissair and Marconi—have also thrown in the towel. And things may get worse before they improve. According to Moody’s, the creditworthiness of American companies has now deteriorated for 18 consecutive quarters, one short of a record.
The equity markets are feeding on this apprehension, and vice versa. Understandably, the world’s largest companies have been most in the firing line: they have the biggest debts and are most affected by the worsening conditions in the credit markets. Not surprisingly, their shares have taken a beating. Indeed, investors who ditched the shares of global titans at the beginning of 2001 in favour of those of smaller fry have generally done better, although both have lost value during the period. Despite choppy markets, as the chart shows, smaller companies in general have outperformed the biggest ones by some 24%.
Nothing is certain in these markets. Who would have imagined even six months ago that, during September, the German stockmarket would have fallen by the most in local currency terms of any market anywhere in the world (with a drop of more than 25%)? Or that, according to the FTSE All-World stockmarket index, during the same month the best-performing sector—personal care and household products, usually a defensive industry when the economy sours—would actually fall in value by 1.8%? The worst-performing sector—information technology hardware—was down by ten times that amount.
It is perhaps not surprising that investors are confused or that sentiment is low. Markets have been so volatile of late that it has been hard to tell which way they would lurch next. The VIX index of volatility (produced by the Chicago Board Options Exchange) has jumped around like a yo-yo since the summer. In other words, even volatility has become more volatile. With the prospect of war in the Middle East and America’s economy seeming to stutter, the one certainty is that investors will be kept guessing for some time to come.
Posted by DeLong at October 11, 2002 10:11 AM | Trackback