It's Too Early to Buy Bank Debt

OK, so we're more or less through bank earnings season. We had some highlights (Wells Fargo (WFC - commentary - Cramer's Take)) and some low lights (Wachovia (WB - commentary - Cramer's Take), Washington Mutual (WM - commentary - Cramer's Take)).

The good news: Few banks saw an immediate need for fresh capital. The bad news: Credit losses continue unabated, with few signs of improvement.

We also got a scare out of Fannie Mae (FNM - commentary - Cramer's Take)and Freddie Mac (FRE - commentary - Cramer's Take), roiling the bond market and spurning a massive government bailout. Now that the long believed implicit backing has become explicit, the GSE's liquidity position looks strong.

So where do we go from here with credit spreads? While I acknowledge the possibility that we've bottomed in credit, I remain bearish.

First, let's look back at the fall -- then rise -- of the markets around the time of the Bear Stearns collapse. We'll zero in on financial corporates and junk bonds (using the Lehman Brothers indices for both), as these are the high volatility areas of the bond market these days.

For comparison, I've also thrown in financial stocks as measured by the Amex Financials Index -- on which the Financial Select Sector SPDR (XLF - commentary - Cramer's Take) is based. This chart will cover Jan. 1 through May 6.

Fall & Rise, Part 1

Click here for larger image.

For the corporate bond components, the graph shows the percentage excess return (or return of the bond less the return on Treasuries, think of it as your return with interest rate risk hedged away). For financial stocks, the total return in percentage is graphed.

What we see is that financials hit a low at -20% on March 17 -- the day after JP Morgan's (JPM - commentary - Cramer's Take) deal for Bear Stearns. At that point, the bonds of financial companies had fallen 6.5% vs. Treasuries, and high yield had fallen 10.3%. Then there was the rebound in April and early May, but let's put that aside for a moment.

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At the time of publication, Graff had no positions in the stocks mentioned, although positions may change at any time.

Tom Graff is a Managing Director of Cavanaugh Capital Management, a registered investment advisor in Baltimore Maryland. The opinions expressed here are Graff's own and in no way are the statements of Cavanaugh Capital Management, and may or may not reflect the strategies being pursued for clients of Cavanaugh Capital Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Graff appreciates your feedback; click here to send him an email.