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IF YOU'RE LOOKING FOR CREDIT, you're better off being a junk-rated company or, even better, a hopelessly over-indebted European country than a small American business or consumer.
The Federal Reserve's latest survey of senior bank loan officers showed lending standards remain stringent, with only a slight loosening for large- and medium-sized business. But sales of junk bonds are booming and the European Union and the International Monetary Fund agreed to a €110 billion ($147 billion) bailout for Greece.
A sharp decline in the yields of speculative-grade bonds historically has meant, ipso facto, an economic expansion was to follow. That's because it always worked that way. The forces that drove the capital markets and bank credit were one and the same. But that is the record of typical economic cycles, not one resulting from a debt bubble and ensuing credit collapse.
"Most banks kept their lending standards unchanged in the first quarter, but that moderate net fractions of banks further tightened many terms on loans to businesses," according to the Fed's latest quarterly survey, the results of which were released Monday.
This comes as the Fed wound up its myriad facilities to bolster credit and ended its "quantitative easing" that resulted, in round terms, a doubling in the size of the central bank's balance sheet. The Fed's survey and its data show that little of this liquidity has trickled down to small-business and consumer borrowers.
Commercial and industrial loans have contracted 19% in the past 12 months. Consumer credit is down 6% in the year to February, when it stood at the same level as June 2007. Banks can't be blamed entirely for the curtailment of consumer credit since much of it was funded in recent years by the "shadow banking system" of asset-backed securities.
Meantime, banks are gorging on Treasuries, with their holdings soaring $63 billion in just the past five weeks, David Rosenberg of Gluskin Sheff notes. As explained in this space two weeks ago by David P. Goldman, editor of First Things magazine, banks have been turned into a virtual public utility financing the federal deficit. ("Steroid Era Ends for Finance," April 20,)
But it's boom time in the junk-bond market. Bloomberg reports that below-investment-grade companies issued $33.7 billion in bonds last month, a record for any April. That's been made possible by the influx of cash into junk-bond mutual funds from yield-starved investors.
The economic impact of the two types of credit is quite different, however. While small businesses are the engine of employment, a significant portion of junk-bond issuance has gone to pay off earlier investors, which doesn't raise additional capital for expansion.
So far, the U.S. economy has been able to bounce back on the strength of government stimulus programs and despite the lack of private credit expansion. With the thrust from the government waning, it remains to be seen what will replace it.
IN NEWTONIAN FASHION, the stock market had a nearly equal and opposite reaction Monday to Friday's decline. The Dow Jones Industrial Average and the Standard & Poor's 500 both tacked on 1.3% while the Nasdaq composite gained 1.5%.
Monday's session posed a crucial test for the market, according to Dennis Gartman, editor of the widely read letter bearing his name that covers the full spectrum of markets, from commodities and currencies to credit and equities.
Mondays have been the strongest day of the week since the bull run began March, 2009, he observes, while the first business days of the month have consistently seen new money flow into the market.
After Friday's "horrific" market action, stocks absolutely had to rally sharply Monday or else the bull run would be in jeopardy, Gartman writes. So, the bulls managed to clear that hurdle.
Paul Macrae Montgomery, who pens the Universal Economics letter, notes a "glitch" last week in his models that has had him on the bullish side of the market since March 2009.
The Buying Pressure from the widely followed Lowry service fell while Lowry's Selling Pressure increased sharply. "This was the worst performance in the Lowry data since October 2008," Montgomery noted.
The market also suffered two sessions where volume of decliners led advancers by a 9-to-1 ratio with no offsetting 9-to-1 up days, Montgomery adds. While that doesn't mean the market can't grind higher, "it does suggest, however, that the easy buy-and-hold time is past; and strategy and selectivity are now orders of the day for equity portfolios."
Comments: randall.forsyth@barrons.com
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