Hedge fund issues could cause economy to slow
Hedge fund issues could cause economy to slowWhile hedge fund failures are typically seen as a Wall Street problem, economists are forecasting that recent hedge fund meltdowns could impact Main Street and may even slow the U.S. economy. Turmoil in credit markets could push up borrowing costs for businesses and consumers and cause a ripple effect.
Hedge fund woes could hit Main StreetUpheaval in credit markets could hit consumer, business borrowing - and slow the economy; risk premiums already rising.
By Chris Isidore, CNNMoney.com senior writer
June 21 2007: 3:21 PM EDT
NEW YORK (CNNMoney.com) --
When Bear Stearns's hedge funds melted down this week because of too big a bet on subprime mortgages, it may have seemed like a Wall Street problem.
But numerous economists said the latest turmoil in the nation's credit markets could spill over to Main Street as well, raising borrowing costs for consumers and businesses alike - and possibly putting the brakes on the surprisingly resilient U.S. economy.
Subprime mortgages, made to home buyers with less than top credit ratings, have been skidding since early this year as delinquencies and foreclosure rates soared. Now problems with those mortgage loans have sparked a big headache for Bear Stearns (Charts, Fortune 500) and the Wall Street firms that lent it money to invest in subprime mortgages, such as Merrill Lynch (Charts, Fortune 500), JPMorgan Chase (Charts, Fortune 500) and Citigroup (Charts, Fortune 500).
But the problems threatening the credit markets could mean far more than just billions in possible losses for those firms. It could push rates higher for corporate debt, which has been relatively cheap even for companies with poor credit ratings.
Even if those companies don't fall behind in their debt payments the way many subprime borrowers have on their mortgages, the investors making money available for those riskier loans are now demanding a much higher premium than they had until just recently.
Deadly ripples threaten subprime funds That could choke off the supply of relatively cheap money that has kept the U.S. economy humming in recent years, putting a dent in everything from business investment to consumer spending.
"That's clearly high on my list of things to worry about," said David Wyss, chief economist at credit-rating agency Standard & Poor's. "I think it's healthy that pricing for risk changes. I think it's too loose now. But the transition could be painful. It depends on how fast it happens."
Wyss doesn't believe that the rise in borrowing costs for most companies will plunge the U.S. economy into recession - and many economists agree with him. They said there's enough underlying strength in the economy to keep it growing. But it will mean slow growth in the second half of this year rather than more normal "trend" growth of 3 percent a year or greater, said John Silvia, chief economist at Wachovia.
"I would think that that as you reprice risk, it will have a negative impact on economic growth going forward," said Silvia. "It will extend the workout in the housing market. And at the margin, they [higher rates] will crimp consumers and their spending."
Others see an even more drastic correction. Peter Schiff, president of Euro Pacific Capital, a brokerage firm specializing in overseas investments, said he had already been expecting a recession in late 2007. Now he believes the recession will come sooner, and hit harder, because of the problems with the Bear Stearns hedge funds.
"This is just another graveyard they can whistle by," he said, referring to Wall Street firms. "Eventually they're going to be overwhelmed. Interest rates are going to rise across the spectrum, and spreads are going to widen considerably."
That widening of the spreads - the difference between what it costs top borrowers and those deemed more risky - has already started. The spread between corporate debt that is not investment grade, popularly known as junk bonds, and a basket of U.S. government bonds was 2.89 percentage points on Thursday, according to Wyss, up from a record low of 2.65 percentage points on May 25.
Wyss said the spread had gotten too narrow and that a correction was likely even without the Bear Stearns problems. A more typical spread is close to four percentage points, and it was as high as 3.85 percentage points as recently as last September.
But he said an event in the credit market such as this week's meltdown typically sends spreads soaring. He noted the rise of roughly one percentage point in just two months in 2005 from a then record low in March following General Motors (Charts, Fortune 500) and Ford Motor (Charts, Fortune 500) debt being cut to junk bond status for the first time.
Full articlehedge funds, economics, capital markets, interest rates, bond yields, valuations, CDO, credit derivatives, derivatives, pooled securitiesLabels: bond yields, capital markets, CDO, credit derivatives, derivatives, economics, hedge funds, interest rates, pooled securities, valuations
Despite record, S&P 500 stocks a bargain
Despite record, S&P 500 stocks a bargainStocks that make up the Standard & Poor's 500 are 45% less expensive relative to historical profits than when the index last peaked, and 30% cheaper than when it fell to a decade low nearly five years ago. The S&P 500 closed at 1,530.23 Wednesday, surpassing a previous high in March 2000.'
S&P 500 Stocks Are 45% Cheaper Than When Index Last Hit RecordBy Michael Patterson
May 31 (Bloomberg) -- Companies in the Standard & Poor's 500 Index may still be a bargain after the benchmark for U.S. equities surpassed its 2000 record.
The index's 500 members are 45 percent less expensive relative to historical profits than when the index last peaked, and 30 percent cheaper than when it fell to a decade low in October 2002. Price-to-earnings ratios declined after companies reported 14 straight quarters of 10 percent-plus profit growth, the longest streak since 1950.
The S&P 500 rose 0.8 percent to 1530.23 yesterday, eclipsing its previous high of 1527.46 set March 24, 2000, led by Exxon Mobil Corp., Goldman Sachs Group Inc. and Apple Inc. The gauge, whose members have a median market value of $14 billion, rallied 7.9 percent this year after first-quarter earnings climbed three times more than analysts' estimates.
``The market is definitely much more fairly priced than it was back in 2000,'' said Michael Mullaney, who helps manage $10 billion at Fiduciary Trust Co. in Boston. ``It's on a much more solid fundamental footing -- we're in pretty good standing for at least the remaining part of the year.''
Investors plowed $199 billion into mutual funds dedicated to U.S. equities during the 10-month stretch leading up to the 2000 record, including $36.5 billion in February of that year, the biggest increase in any month during the past nine years, according to data compiled by TrimTabs Investment Research in Sausalito, California.
Price-Earnings The flood of money into the U.S. stock market helped boost the average price-earnings multiple for S&P 500 shares to 32.8 in March 2000. That compares with a 25.7 average earnings multiple when the market fell to a low in October 2002 and an 18 multiple today.
The S&P 500 plunged 49 percent between March 2000 and Oct. 9, 2002, dragged down by an 82 percent decline in computer- related shares. Those stocks had surged more than 12-fold during the 1990s and led the S&P 500's record-breaking rally.
The index climbed 26 percent in 2003 as the Federal Reserve trimmed interest rates to the lowest since 1958. The so-called federal funds target remained at 1 percent for a year before policy makers raised it 17 straight times.
Other U.S. equity benchmarks have performed better than the S&P 500 since March 2000. The 30-stock Dow Jones Industrial Average has climbed 23 percent during the period, while the Russell 2000 Index, consisting of companies with a median market value of $664 million, has gained 47 percent.
Asia, Europe Shares in Asia and so-called emerging markets have also outperformed the S&P 500 since 2000. The Morgan Stanley Capital International Asia-Pacific Index has jumped 26 percent since 2000 and is valued at 19.2 times historical profits. The MSCI Emerging Markets Index has soared 94 percent and trades for 15.2 times past earnings.
The Dow Jones Euro Stoxx 50, a measure for the 13 nations sharing the euro, has a price-earnings multiple of 13.9 after it declined 17 percent.
The Nasdaq Composite Index, which gets more than two-fifths of its value from computer-related shares, is still 49 percent below its March 10, 2000, peak.
Energy and utilities shares led the S&P 500's rally, climbing about threefold since October 2002. Exxon, the world's largest oil company, contributed the most to the advance as it surged 156 percent. Williams Cos., the biggest U.S. pipeline operator by market value, jumped more than 21-fold for the top gain in the index.
``Lingering nervousness'' about the market's plunge from the 2000 peak spurred many investors to reduce their holdings of U.S. stocks even as the S&P 500 rallied, said Kevin Bannon, chief investment officer at Bank of New York Co. Pension plans, wealthy individuals and other investors poured money into hedge funds and international stocks instead, Bannon said.
Fund Flows About $8.6 billion was siphoned from U.S. equity mutual funds since May 2006, just before the S&P 500 fell to a seven- month low, according to TrimTabs data. Meanwhile, mutual funds that invest in international stocks raised $113 billion during the same period.
Hedge funds globally attracted $120 billion during the past three quarters, according to Chicago-based Hedge Fund Research Inc. Total hedge fund assets ballooned to $1.6 trillion last quarter from $490.6 billion in 2000. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets and participate substantially in profits from money invested.
``The crash in the market scared people -- most of the traditional buyers are re-allocating assets into alternatives,'' said Bannon, who helps oversee $120 billion in New York. ``All these private equity buyers see the real value.''
Takeovers The S&P 500's 25 percent rally from its 2006 low in June was fueled by a record pace of takeovers.
Mergers and acquisitions totaled about $1.7 trillion in 2006, breaking a record set in 2000, according to data compiled by Bloomberg. Announced deals this year amount to more than $1.1 trillion, 61 percent ahead of last year's pace.
Dow Jones & Co. jumped 55 percent on May 1 after Rupert Murdoch's News Corp. bid $5 billion for the publisher of the Wall Street Journal. TXU Corp. climbed 25 percent this year after investors led by Kohlberg Kravis Roberts & Co. and TPG Inc. bid $32 billion for the largest power producer in Texas.
The surge in acquisitions was spurred in part by the widening gap between what companies yield in earnings and the cost of borrowing, said Sean Clark, chief investment officer at Clark Capital Management.
Estimated profit at companies in the S&P 500 represented a yield of 6.53 percent at the end of the first quarter, when 10- year U.S. Treasuries yielded 4.65 percent. The 1.88-percentage- point advantage was the biggest since at least 1986. As of yesterday, the gap totaled 1.24 percentage points.
``One reason why there's been so much M&A activity with the private equity firms is because valuations are so palatable right now,'' said Clark, who oversees about $1.2 billion in Philadelphia. ``The market is more reasonably priced, especially compared to bonds.''
To contact the reporter on this story: Michael Patterson in New York at
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