Stocks Fall, Bonds Rally on Recession Worries

Nervous investors have finally begun to step back and appraise the risks of the current market and have decided to take some profits off of the table. As of 3:00 EST all major indexes were off over 3% led by the S&P which was down 3.2%. Those dollars seems to have found a home in treasuries. Treasury prices rallied sending yields back under 4.8% for the first time since the middle of May. As many have predicted, renewed uncertainty about the direction of the market has helped the VIX volatility index reach a 13 month high at 21.95.

There are an abundance of scare factors in the current market. Just check out the list below. This is far from comprehensive but I feel it does highlight some of the main issues:

1. Housing Market Slowdown- What started as a meltdown in the subprime market, has led to tightening credit, skyrocketing foreclosures, construction layoffs, the lowest building permit numbers in a decade, rising mortgage rates, contagion spreading to the alt-A and prime markets and the risk that the housing market weakness could extend well into 2009.
2. Oil Prices - Prices have risen steadily this summer and topped $77 in trading this morning, before settling back down near $75. Even at $75 oil is up over 50% from earlier this year. We are certainly threatening the highs of last summer when crude trading into the $80's before falling in the winter.
3. Consumer Spending - The housing slowdown and rising gasoline prices are starting to eat a hole in consumer's wallets. Retailers, grocers, automobile companies and hotels will be among the first to feel the squeeze. Just this week grocer Supervalue indicated that sales have slumped in the beginning of the third quarter. If consumers clamp up it will be virtually impossible to avoid a recessionary environment. Nouriel Roubini points out that recent data on weekly chain store retail sales suggest that the softness of retail sales in June is extending to July.
   
4. High Yield Debt Market - A lower tolerance for risk among banks has led to rising yields, putting pressure on the financing of merger transactions. The credit squeeze makes private equity firms less likely to pursue major deals to keep the market rallying. Over the past two weeks Blackstone's $12 billion Chrysler financing and KKR's $10 billion Alliance Boots financing hit major snags and were postponed. Investors it seems just can't stomach any more risk in spite of low default rates. This does not bode well for the rest of the $400 billion of merger activity in the pipeline. The credit crunch isn't just effecting the major deals, in total over 32 deals have been postponed, sweetened or restructured in the past month. Meanwhile high yield credit spreads have risen 54% since the beginning of June.
   
5. Corporate Capital Expenditure Weakness - Economists were surprised by a half point decline in durable goods orders in June. The feeling that after a dismal Q42006 and Q12007 capital expenditure would surely rebound in the second half of 2007 is beginning to look more and more like "wishful thinking." Businesses are likely looking at slow consumption growth and wondering why they should spend more money than they have to. In fact economists surveyed by the WSJ identified slow CapEx spending as the biggest threat to the US economy.
6. Recession Odds: In review, the dismal first quarter GDP number of 0.7% even when combined with a strong second quarter of 3% (a guess) still only leave us with 1.8% in H1. If the risks above term out as I expect, growth in H2 should not improve much, if at all, on the 1.8% number. If there was a 12 month recession probability index, it would have gapped up this week.