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Headed for a fall or looking strong?

Kai Ryssdal Jul 16, 2007

Headed for a fall or looking strong?

Kai Ryssdal Jul 16, 2007


KAI RYSSDAL: The Dow Industrials closed the day at their umpteenth record high of the year. Nudging up against the 14,000 mark. Given the way things have been going on Wall Street the past few sessions, you’d be forgiven for thinking the good times are here again.

They may well be, but not everyone believes that. Specifically, investors in what’re called the options market. Where there are some signs Wall Street’s gone a little too far, too fast. We got economist Mark Zandi from Moody’s Economy.com on the line to explain what exactly that means.

Mark, good to talk with you.

MARK ZANDI: It’s good to be with you.

RYSSDAL: Let’s make sure everybody knows exactly what we’re talking about. What are these option indexes here?

ZANDI: These are options to purchase the S&P 500 index, or sell the S&P 500 index. It’s really a bet on whether the market’s going to rise or fall in the future.

RYSSDAL: And the numbers we were seeing this morning predicting a drop of 5 percent, 10 percent, as much as 19 percent in the S&P 500 in the next six months or so. How does that strike you?

ZANDI: Well, you know, 5-10 percent decline is in the realm of historical experience. That’s a garden variety kind of correction, and we haven’t had one of those in quite some time. So, if you told me there was going to be a correction like that in the next three, six, nine months, I don’t think I’d be too surprised. Now, 19 percent, that’s serious stuff. But 5-10 percent, that’s pretty standard.

RYSSDAL: All right. But let me run this one by ya. I mean, we have been weathering in the stock market now the subprime fallout, private equity piling up loads of debt that it may or may not be able to pay back. Rising bond yields. Is there something you think that might trigger this fall?

ZANDI: Well, the market does seem a bit extended. Credit spreads are incredibly narrow by historical standards. Investors are taking lots or risk.

RYSSDAL: Define that term for us — credit spreads.

ZANDI: Yes, good point. If you look in the bond market and look at yields on risky bonds, junk bonds or subprime bonds — not subprime bonds now but junk bonds, emerging debt — the yields are very thin relative to risk-free interest rates, on Treasury bonds, for example. What that means is that investors aren’t asking for too much compensation for all the risk that they’re taking. And that compensation now is incredibly narrow by historical standards.

RYSSDAL: OK, so what other triggers might be out there in the market that we might look at?

ZANDI: Well, given this lack of concern about risk, any kind of risk that does appear is likely to spook investors. Obviously, the most pressing potential risk is what’s going on in the housing and subprime mortgage market. That’s still unraveling. I think mortgage quality will continue to weaken right through this year into next. So, that’s a problem that’s still yet to play out.

RYSSDAL: Let’s just chat real briefly about one of the other things tjat people talk about when they talk about the markets: fundamentals. I mean, how do you feel now about some of the things underlying the market that may or may not influence the way it goes?

ZANDI: Well, I think the fundamentals are OK. The economy is expanding. We’re almost six years into an economic expansion. And I think what’s driven the market in the last few days, couple weeks, is the relief that the economy is going to be able to digest the housing downturn and the mortgage-market mess without falling into recession. I think there was a lot of concern about that. There’s been a lot of stress. But I think people, investors are coming to the realization that this economy is resilient and it’s going to make its way through without unraveling.

RYSSDAL: Mark Zandi’s the chief economist at Moody’s Economy.com. Mark, thanks a lot.

ZANDI: Thanks for having me.

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