June 20, 2007 / 5:04 PM / 13 years ago

Credit market risks not rattling stock buyers...yet

NEW YORK (Reuters) - Fears that a blow-up in high-yield debt markets may lie just around the corner are making some equity investors edgy, but few expect an event large enough to derail the bull market in stocks.

That faith was put to the test early on Wednesday after reports that two large hedge funds run by Bear Stearns Cos. BSC.N were on the verge of collapse after big bets on the subprime mortgage market went awry.

In the early going at least, stock investors appeared to be taking the developments in stride, and benchmark equity indexes were modestly higher, with the Dow Jones industrial average .DJI up 0.10 percent.

“It might be enough to scare it off for a correction but it’s not enough to scare it off to end the bull market,” said Ken Fisher, author and chairman of Fisher Investments.

Wall Street would probably weather any fallout from a storm in the credit markets as long as stocks continue to return more than bonds, and as long as growth overseas continues to buoy U.S. manufacturers, analysts said.

Still, a jump in bond yields above 5 percent also has prompted plenty of nervous chatter that higher interest rates will shut off the easy money fueling the leveraged buyout boom.

That’s a real concern to stock investors because, with most analysts agreeing the peak of the corporate profit cycle has passed, the frantic pace of dealmaking has been the main driver of U.S. stock markets this spring.

To end the rally you would need “a massive increase in long rates or a massive increase in stock prices or some combination of the two,” Fisher said in an interview earlier this week.

More than two years ago Fisher predicted a wave of stock buybacks and takeovers sweeping corporate America would lift equity markets as investors were forced into reinvesting proceeds from the deals into a dwindling number of stocks.

Market interest rates could move as high as 5.7 percent — the benchmark 10-year note US10YT=RR yielded about 5.12 percent on Wednesday — without a disaster, Fisher said.

“I’m not suggesting a half a point raise in long rates isn’t in other regards significant,” he said. “But I don’t think it’s enough to stop the bull market.”

As long as stocks yield more than bonds, that will keep stocks more attractive, he said.

With yields on the 10-year note backing off from a brief high of 5.30 percent last week, there is little evidence of a looming blow-up, said Mike Jones, chief executive at Clover Capital Management, which overseas about $2.7 billion.

“It seems a little abstract to worry about a ‘coming crisis’ when the credit markets are hardly cognizant of any type of risk at the moment. I think most bond guys would settle for just a ‘reasonable spread’ to Treasuries,” Jones said.

The earnings yield of companies in the Standard & Poor's Index .SPX is about 6.25 percent, based on their trading at almost 16 times forward earnings. That means they are yielding at least 1 percentage point more than market interest rates.


Investors who worry about a credit meltdown are not taking into account the world as a whole and are giving the United States too much weight in their outlook, Fisher said.

The U.S. and non-U.S. stock markets, the same as the U.S. and non-U.S. economies, are not negatively correlated and have not been for a very long time, he said.

“The people who are making these arguments are far too U.S.-centric,” he said.

Industrial production rose among members of the Organization for Economic Cooperation and Development from 1995 to 2000 at about the same rate as that of Brazil, China, India, Indonesia, Russia and South Africa, according to research by Ed Yardeni, chief investment strategist at Oak Associates.

Since 2000 through last November, OECD-member output rose about 9.7 percent, while industrial production at the OECD and the six big emerging countries was 28.8 percent, Yardeni said.

People don’t realize the contribution of emerging economies to world growth, said Shigeki Makino, chief investment officer for the global core equity team at Putnam Investments.

Faster growth from emerging economies has caught industries by surprise as they failed to boost plant capacity to meet the demand. That’s created a backlog in airplanes, shipbuilding, refineries and plant-equipment orders, Makino said.

“There’s a certain sustainability as their agrarian economies shift to urban industrial economies,” Makino said.

However, some investors do see reason for concern. The jump in market interest rates should make investors more aware of risk and the possibility of a market correction, said Joseph Battipaglia, chief investment officer at Ryan, Beck & Co.

A decade-low in corporate tax rates could change while investor demands for bigger dividends and stock buybacks squeeze margins and take the shine off a near picture-perfect environment for stocks, Battipaglia said.

“We could see a meaningful reversal at some point, about 5 to 10 percent, so investors need to have a much more attuned sense of risk coming back into the equation,” he said.

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