Garbage and Potatoes / Hussman

Interesting chart once again from Hussman. Click on the headdline to read the entire piece

Mal wieder ein interessanter und nicht alltäglicher Chart von Hussman. Klickt bitte auf die Überschrift um den kompletten Report zu lesen.

To offer an idea of how much the recent advance has represented a speculative run on “low quality,” Bill Hester put together the following chart. It presents the performance of stocks rated “high quality” by Standard & Poor's, compared with the performance of all stocks with an S&P quality rating. Presently, the capitalizations being awarded to “garbage stocks” are very rich. Historically, these extremes haven't persisted.

The chart above is through the end of 2006. The same relative performance can be observed in the debt markets, where junk has clearly outperformed higher rated debt in recent years. It's notable that the “quality spread” in stocks has begun to reverse in recent weeks, along with risk spreads in the corporate bond market. Note that the yield spread on the CBOT's new credit default swap (CDS) index has just moved to a fresh high. A credit default swap is a way of transferring credit risk from one holder to another – a rising spread indicates increased concern about default risk. This will be important to monitor in the weeks ahead.

As I've often noted, the worst situation for an investor is when risk premiums are low and are being pressed higher. When that happens, stock and corporate bond prices can weaken significantly because the only way to get the yield (and risk premium) up is to drive down the price, and it takes a substantial amount of price decline to bring a low yield to higher levels.