Thursday, July 26, 2007

Contagion in the credit markets?

The markets were once again singin' the ol' sup-prime mortgage blues today. However, I believe that fears of a meltdown in the credit markets are way overblown. For one, corporate balance sheets are pretty healthy after years of record-high profits and modest leverage. In fact, spreads between BAA corporates and Treasuries have stayed pretty stable (however, I don't have data for the past couple of days).

The real problem lies with consumers and certain financial firms, where leverage has grown strongly, as this graph shows.

Outside the financial sector, my one big worry is what impact falling home prices will have on consumers. So far, American consumers have, as always, withstood the storm. But for how long? Only time will tell, but in the meantime I'd avoid stocks exposed to U.S. consumer demand.