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Wednesday, October 1, 2008

Credit Crisis Chart, No Bottom in Equities

“Funding markets are in complete disarray. With no interbank lending taking place, the daily Libor fixings are no more than a flimsy theoretical construct.” -Christoph Rieger, fixed-income strategist

“Aside from the overnight, which is completely awash with cash, term-lending conditions in the money market are as illiquid as ever.” –Don Smith, fixed-income strategist

Inspired by one of the charts over at Cobra’s Market View I’ve put together a Credit Crisis Chart. (For Cobra’s Credit Risk Watch chart click here.)

The Credit Crisis Chart explained:

1) This chart mainly tracks the ratio of Libor to the 1 month US Treasury Yield in line chart format ($LIBOR:$UST1M, black and red line chart).
2) In the background is the New York Stock Exchange Composite ($NYA, grey area chart).
3) In the background is a measure of volatility as measured by the VIX index ($VIX, green area chart).

How to read the Credit Crisis Chart:

1) As the LIBOR and 1 month US Treasury Yield difference narrows, equities on average have risen.
2) As the LIBOR and 1 month US Treasury Yield difference narrows, volatility on average has dropped.
3) A simple trading system would BUY(SELL) equities on a cross DOWN(UP) of the 20 and 50 day EMAs (blue and red lines) below the 200 day EMA (green line).
4) A simple addition to the strategy would be to BUY additional equities on volatility spikes that are NOT accompanied by a spike in the LIBOR US Treasury spread.
5) A simple addition to the strategy would be to SELL equities short on drops in volatility that are NOT accompanied by a drop in the LIBOR US Treasury spread.
6) Currently, the LIBOR US Treasury spread is so large that stresses in the financial system have reached the breaking point. This is accompanied by an elevated level of volatility. It is therefore probable that equities still have a ways to fall. Therefore, going long stocks for the ‘long term’ is still a bad idea.

via Across the Curve: Libor:

“Overnight Libor has set at 3.79 percent, down significantly from the quarter end pressured level of the previous day. And even though it has been set lower, it remains stressed and elevated.

Longer maturities along the Libor curve have seen rates rise. Three month Libor was set 10 basis points higher at 4.15 percent.

It is too early to make an unequivocal statement but the early returns indicate that the turn of the calendar page to October 1 has not alleviated the stresses and strains extant in the short term money markets.”

Libor Overnight Rate Drops as Quarter-End Funding Squeeze Eases: “The cost of borrowing in dollars overnight fell from a record after funding constraints tied to the end of the third quarter passed, easing an unprecedented freeze in lending between banks.

The London interbank offered rate, or Libor, that banks charge each other for overnight loans slid 308 basis points today to 3.79 percent, the British Bankers' Association said. It surged to 6.88 percent yesterday. The one-month euro rate climbed to an all-time high of 5.07 percent, and three-month dollar loans rose to the highest level since January. The Libor-OIS spread, a gauge of cash scarcity, held near a record.

Credit markets have seized up as banks balk at lending to each other amid heightened concern that more of their peers will collapse. Governments in Europe and the U.S. have rescued five banks in the past week.

Financial institutions deposited a record 103 billion euros ($146 billion) with the European Central Bank yesterday as lenders sought a haven for their money. The ECB today increased the amount of dollars it offered banks overnight by 67 percent.”

Despite the best efforst of all the central banks in the world, global liquidity continues to drain away into the black hole of large scale debt destruction.

I continue to short into equity rallies and cover on big drops…


ARAK said...


Where do you project equities will stop their downward momentum eventually? Say 700 on the SPX around end of 2009? With a majority of the move coming after end of day tomorrow (after the senate pases the bill and we get the final resulting pop)?

Jonny said...

I'm obviously not Ben, but want to note that passage in the Senate is not what will be moving the markets, rather it's the House that's the sticking point, and I do expect a bounce (if and)whenever that's "assured" (maybe before the actual vote). After that, I too expect the markets to be headed back downward, though I'm sure there will be rallys, maybe even extended ones (multiple weeks).

Anonymous said...


What do you think this will do to Goldman in the next week. Quick bounce after passage followed by fall?

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