Equity-Bond Disconnect Redux

One of the regular features that Bloomberg provides to subscribers is its Chart of the Day column, which marries a graph produced using the functions available through the professional service with an article written by one of its editorial staff members.

In today’s edition, “Bank Bondholders ‘Losing Faith’ as Shares Surge: Chart of Day” [no link available], columnist David Wilson highlights the divergence between equity and fixed-income markets, a disparity that I’ve often made reference to here at Financial Armageddon.

Shares of the largest U.S. banks have rebounded with a vengeance during the past four weeks. Their credit-default swaps haven’t kept pace.

The CHART OF THE DAY shows the disconnect between how Bank of America Corp. (BAC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) have fared in the stock market and how CDSs on their debt have performed.

Their share prices surged as much as 155 percent from March 10 through yesterday, as the top panel illustrates. The rally started after the Standard & Poor’s 500 Index (^GSPC) set a 12-year low on March 9. Bank of America, Citigroup, JPMorgan and Wells Fargo all surpassed the S&P 500’s 20 percent gain during the period.

CDS rates for every bank except JPMorgan, on the other hand, were little changed yesterday from their March 9 readings. As shown in the bottom panel, they climbed in the second half of March, increasing the cost of insuring against debt defaults.

Bondholders “are losing faith in their ability to be made whole” in light of the U.S. government’s dealings with General Motors Corp., Peter Boockvar, a strategist at Miller Tabak & Co., wrote in an e-mail yesterday. When $1 billion of GM convertible notes mature June 1, the government won’t repay them, a person with knowledge of the discussions said yesterday.

“The bizarre thing is, if bondholders take haircuts, the stocks will go much lower,” he wrote in reference to the banks. So-called haircuts occur when borrowers pay back less than face value, leaving holders of their debt with losses.

Throughout the entire financial crisis, as regular visitors know, the credit markets have been consistently ahead of the curve. My guess is that this time won’t be any different.

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