Bear market has begun'

'Bear market has begun'
By Paul J Davies
Copyright The Financial Times Limited 2006
Published: September 27 2006 03:00 | Last updated: September 27 2006 03:00


Investor views on whether the credit cycle has turned differ widely between the cash and derivative markets, according to strategists at Deutsche Bank.

Gary Jenkins and Jim Reid, heads of credit strategy at Deutsche, said yesterday there was mounting evidence that a bear market was beginning.

The last bull run began towards the end of 2002 with spreads on Baa-rated long-dated bonds over Treasuries peaking at about 300 basis points. That spread had more than halved by March 2005 and has since widened again by more than 40bp.

However, the views of investors are likely to differ widely depending on whether they are exposed to the cash bond market, or the market for credit default swaps, which offer insurance against non-payment of corporate debt.

"Cash investors are more likely to say that the peak has passed," said Mr Jenkins. "The low default rate of recent years has been kinder to the CDS market."

This is because the market for CDS trades and structured products built on the back of them instrinsically places more importance on default rates than on the value of returns from being invested in bonds.

This has helped the main European CDS index outperform the main cash bond index since June. But once defaults begin to rise, cash investments are likely to outperform again, they said.

The coming bear market could be protracted following on from the longer up and down cycles witnessed since the start of the 1990s, they said.

Credit and other asset cycles depend on the economy and Mr Reid and Mr Jenkins pointed to two pieces of evidence that auger ill for the US particularly.

First is the coming contraction of the population aged 35-54, who are the main drivers of investment in assets.

The growth of this group has arguably driven the sustained asset boom of the past 25 years, they said.

Second is the sharp fall in sentiment among housebuilders, which is at its lowest level since the early 1990s and shows strong correlation with consumer expenditure.

Mr Reid said figures on Monday were the first to show negative annual house price growth in the US since the depression era.

While they expect bond spreads to remain in a narrow trading range in the coming few quarters, real returns on investment grade and high yield bonds are likely to be disappointing over the next five years if markets revert to historic averages.