With the financial system bailout plan derailed by the House of Representatives on Sept. 29, the resulting plunge in equities made headlines around the world. But while the stocks gyrate, it's important to keep one thing in mind: The big problem for financial markets is still the credit crunch. So as bad as equities have looked -- and during the big Sept. 29 sell-off, they looked pretty bad -- the true indicators investors should be watching are obscure measures such as credit default swaps, TED spreads, and commercial paper volume (all explained below).
These names may sound wonky and insider-y, but they are nonetheless vital to understanding just how difficult, costly, and fearful the credit markets have become. They're the reason the stock market, in general an indicator of investor sentiment, plunged on Sept. 29 after the bailout failed. Without the plan, the markets recognized that the credit markets, the lifeblood of American business, will get worse before they get better. "The market understands the lack of liquidity that exists and the repercussions it will have on companies big and small," says American Capital CEO Malon Wilkis.
Start with credit default swaps (CDS), which act as insurance on bonds and other debt. They've gotten a bad name amid the troubles at American International Group (NYSE:AIG - News), which was a big factor in the CDS market, but they're very good at one thing: measuring fear in the credit markets. And swap spreads, as measured by the CDX, an index of the most commonly traded CDS, rose to 163.7 at the end of last week according to CreditSights, levels unseen in five years and a sign that the credit markets are afraid. Very afraid.