Tuesday, July 17, 2007

In Case You Missed It

As the equity markets flirt with new all-time highs and most US investors focus on earnings season, today's FT Alphaville has a noteworthy posting titled, "Subprime sell-off rattles credit derivative markets". Here is an excerpt from that posting along with three charts showing the plunge in value for key credit derivatives indices:

"The cost of insuring European corporate debt against default spiked sharply on Tuesday, after an index of securities linked to US subprime mortgages fell to a record low.

ING was downbeat about the outlook for the rest of the week, saying in a note: "The week ahead looks set to be fraught with volatility in an illiquid market, which is a very dangerous cocktail considering that the Crossover has already retraced 40 bps off its highs last week."

The iTraxx Crossover index of 50 mostly junk-rated European names jumped 19.5bp to 287bp after a sell-off in the ABX index.

The ABX is an index of credit-default swaps on subprime mortgage bonds and is used by investors to hedge subprime mortgage exposure. Overnight, the lowest-rated portion of the most recent ABX index, which is based on bonds sold in the second half of 2006, slipped 7.5 per cent to 45.28, according to derivatives data provider Markit."

Investment Strategy Implications

For those investors who are getting increasingly comfortable with the idea that we are climbing a wall of meaningless worry and that today's problems are quite manageable, acknowledging that contagion risk still exists seems warranted for a little margin for error, fully valued equity market.

Note: To view a larger version of the above charts, click on each image

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