Every market fell, from New York, where the Dow Jones Industrial Average and S&P 500 lost 2.3%, to London, down 3.2%, to Asia, where Tokyo lost 2.2% and Hong Kong 1.7% in early trading this morning (Friday).
For credit traders, the equity falls brought deeper gloom, but also vindication: for weeks the credit markets have been behaving as if spiralling losses on US subprime mortgages were the beginning of the end for the five year bull run in financial markets. Equity investors have blithely ignored them.
Now, few capital markets sectors are unaffected. Trading in triple-A bonds is subdued, though they will likely benefit from a flight to quality when investors become more active in September.
Price-sensitive corporate and financial institution issuers are holding their fire, though Kimberly-Clark and Honeywell launched impressive and well-received deals in the US this week.
There is plenty of ABS issuance in Europe, but at wider spreads.
In equities, daring deals were sold this week from Asia and Africa, but that was before Thursday’s sell-off. Jollity remains only in convertible bonds, which thrive on volatility.
The main theatre of battle this week was New York’s credit markets, where one weary senior bond banker said this week it was "raining hailstones".
"It’s really ugly. The market is trading like the Fed has to ease at the moment," said another dealer in New York.
Driving the market were the credit default swap indices, which were plagued by aggressive selling for much of the week, but particularly yesterday.
Europe’s iTraxx Crossover index pierced the psychological barrier of 400bp yesterday to close at 410bp bid, 42bp wider on the day. In mid-June it was around 210bp.
According to dealers it’s not over yet, by a long chalk. "It can hit 500bp. People were laughing at this a few days ago, but they’re not laughing now," said a senior index dealer in London.
Another dealer at a leading market maker echoed this figure. "I’ve heard of options selling with 500bp strikes. It’s scary isn’t it?" he said.
That left a half-empty and windswept terrain for cash bond issuers — but there was some action.
"It’s a really morbid atmosphere out there. The credit market is just not pricing deals and other deals are getting held," groaned the head of syndicate at a bulge bracket firm.
Yesterday Tyco cancelled a planned $750m three part deal, underwritten by Goldman Sachs and UBS, while Gazprom announced that it was not going ahead with a 30 year offering through ABN Amro and Morgan Stanley, even though it had released price guidance the previous day.
Like an ageing heavyweight, the US credit market was beaten and battered all week, notably by gloomy second quarter results from Countrywide Financial Corp on Tuesday.
The US mortgage lender announced a 33% fall in quarterly earnings, due to credit costs rising on its prime home equity loans.
This news was the markets’ worst bogeyman this week, because it showed credit problems spreading from the subprime to the prime housing sector.
Rare deals priced
However, the market came off the ropes briefly on Monday to allow Honeywell International to print the market’s first corporate deal for weeks. On Wednesday, Kimberly-Clark somehow found a window for a $2.1bn three part deal.
But by yesterday afternoon, the US credit market had taken several very heavy blows and was sinking to the canvas. Nothing was going to get priced in that environment.
A confluence of factors, rather than a single catalyst, sent the market into headlong retreat yesterday.
By the close, the Dow Jones Industrial Average had fallen by 311 points, while the 10 year Treasury had rallied 11bp to 4.79%. The S&P 500 had retreated, reducing its yearly gain to just 4.6%.
The planned minimum $750m deal from Tyco International, the US electrical equipment and building materials group, was left exposed to the storm. Underwritten by Goldman and UBS, it was supposed to have consisted of a two year floater, a five year straight and a 10 year straight.
Things had been looking rather better on Wednesday, but when the Tyco deal entered the market on Thursday it took the full brunt of the gale roaring through the US markets.
Late in the day, it was announced that the deal had been withdrawn due to unfavourable market conditions.
This came as no surprise to Wall Street. The lead managers were unavailable for comment, but earlier in the day sources close to the deal said they expected the borrower to determine that it would find better funding at a different time.
"We’ve not heard yet that the deal has been pulled, but they probably realise that it is a non-starter on the day. They’ll have to put it on hold," advised one.
No improvement soon
But others cautioned that things would be no better if the leads came back to market next week.
"If it was plus 150bp for Deal X yesterday, it’s not just 170bp now but 170bp-plus. If you pull it, it won’t be plus 150bp again next Monday. That deal is cooked," said one.
Gazprom also decided that discretion was the better part of valour and announced that its planned 30 year 144A benchmark would not price yesterday, as had been planned. Price guidance of plus 220bp-225bp had been released on the previous afternoon.
"Given current market conditions, Gazprom will continue to monitor the market and will look to launch the transaction upon market stabilisation," it said. The deal was also supposed to include a 10 year tranche, but this was abandoned (see story on page 14).
It appeared to dealers on Wall Street that the market threw in the towel yesterday after several weeks of battering. "It felt like people just gave up today. It was like they said, ‘I’ve had enough,’" said a senior dealer.
Another veteran syndicate manager said the market had been driven by the increasingly wide prices on the credit default swap indices, which have existed for only the last three or four years.
"I’ve been doing this for 16 years but what is different these days is that you can express negative sentiment in so many new ways.
"You can express a $1bn short in a nanosecond in the synthetic indices. That adds a whole emotional dimension to the sell-off, and we’ve had today what I’d call panic," he explained.
Europe’s iTraxx Crossover Index widened from around 340bp to over 400bp this week, while the US market’s CDX Crossover lurched 40bp wider to 345bp.
Bankers in New York said that at first market participants had hoped the subprime meltdown would be confined to a small number of market participants. Now, it appeared, troubles in this sector were bleeding more widely into other markets.
The most recent news was that another Australian hedge fund, Absolute Capital, had frozen withdrawals from two of its funds, saying that the whole credit sector was repricing as a result of the subprime fallout.
Moreover, Absolute did not invest in the most risky CDOs. This follows the collapse of Basis Capital last week.
Leveraged mountain looms
After US mortgages, the market most worrying investors is leveraged finance, and there was bad news there, too, as banks abandoned financing packages for buy-outs of Chrysler and Alliance Boots.
Some US debt traders and investors feel they are looking down the barrel of a great deal of LBO financing — around $250bn — which will weigh heavily on spreads.
"People are looking at Home Depot, at Wal-Mart, at a very large calendar of deals. It makes them afraid," said one.
Although the more optimistic market participants still cling to the fact that most parts of the global economy are still in very good shape, the present market turmoil is looking increasingly like it may be setting in for an extended period.
Simon Boughey