Give Stocks Credit!

With a loss of more than 500 points on the Dow yesterday the Dow has now lost 875 points in two days. I don't think as a percentage drop this is a record but it is significant! As the stock market heads down my greater concern is with the bond market. In October of 2007 an investment portfolio of investment grade corporate bonds, with an average maturity of about 4.5 years, was offering a yield of approximately 4.75%. In March of 2008 the yield was about 6%. That same yield is now over 8%. As the interest rate goes up the value of the bonds goes down! To make matters worse, the average yield on high yield bonds during the same periods went from approximately 7.25%, to 11.85% and is now over 18%! These are very significant changes. To put all of this into perspective: currently the return on U.S. Government debt is paying interest of 1.68% on the three year, 2.46% on the five year and 3.5% on the ten year debt. What this means is that most of the money leaving the stock market, commodities, etc. is going into U.S. Government instruments. Yesterday the Federal Reserve indicated that they will begin major investments into commercial paper, which is short term lending covering a period from overnight to less than a week. This is an area that is very important to business borrowing. It is hoped that with this move credit markets will free up and money will move into other credit markets such as corporate bonds. If this happens we are likely to see interest rates on investment grade and high yield bonds begin to fall. Ultimately, when the credit market starts to free up the environment for business will get better. Over time this should lead to stock prices stabilizing and bring confidence back to the market. This will not happen overnight but will take time. We must learn patience!