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Liquidity Fears Evaporate

Liz Rappaport

Fear of the unknown and a sense that there is more correction in credit markets to go is fostering wild swings in the stock market. But investors ended another session with a positive bent Wednesday.

The bullish argument that the strength of the global economy will uphold the markets took center stage following Cisco Systems'(CSCO Quote - Cramer on CSCO - Stock Picks) chief executive's comments on the company's earnings conference call Tuesday night.

"In 30 years, this is the strongest global economy I have been a part of," said Chambers on the call. The company also increased its earnings guidance. Cisco gained 6.7% on the day.

The Dow Jones Industrial Average surged 153 points, or 1.1% to close at 13,657.86 while the S&P 500 added 1.4% and the Nasdaq Composite jumped 2%.

"Chambers reminded everybody of what the key drivers of this market have been, credit issues notwithstanding," says Art Hogan, chief market analyst at Jefferies & Co. "You have a global growth rate of 4.5% to 5%. That's what the global markets' strength is all about."

Certainly, the global economy can falter too, as central banks reach the apex of their tightening cycles and inflation remains a problem in countries like China. But while it lasts, the $1 trillion of currency reserves in China, among other lender nations, remain a strong driver of global liquidity.

The credit markets likewise eased up Wednesday. A robust reopening of the high-grade corporate credit market after a long dry spell also supported the theory that liquidity is still plentiful enough to avoid crisis.

Wall Street's corporate bond syndicate desks spent the afternoon pricing 10 investment grade bond offerings Wednesday as the window of opportunity opened after a nearly monthlong period of stillness. But despite a good day of dealmaking, many credit market participants remain cautious about the outlook.

"Plenty of companies need to borrow and seem prepared to do so --- but deals will complete largely on buyers' terms," says Edward Marrinan, head of investment grade fixed-income strategy at JPMorgan Chase. ""There is no escaping the fact that the credit markets still have to contend with a full pipeline of committed but unsyndicated financing facilities related to LBOs and other leveraged loan transactions. The completion of these deals looms as a major challenge for the market."

The deal flow Wednesday will make for the strongest issuance week in the high-grade credit market since the week ending July 13, when $18 billion was priced. Wednesday's deals alone included offerings of $1 billion or greater from Merrill Lynch (MER Quote - Cramer on MER - Stock Picks), Citigroup (C Quote - Cramer on C - Stock Picks) and Kraft (KFT Quote - Cramer on KFT - Stock Picks).

Investors say the deals are coming with some concessions, or higher yields than in the pre-credit crunch days. They are being offered to buyers by the undewriters anywhere from 5 to 15 basis points above comparable issues in the marketplace.

There also are several smaller $250 million to $500 million deals in the market from utilities such as Wisconsin Power & Light and Public Service Co. of Colorado, among others.

"The real test of the currently restored health of the new issue market will come with the performance of deals in the secondary market," says Marrinan.

As of Wednesday afternoon, the Public Service Co. of Colorado's $350 million offering and Kraft's deal were trading up by 5 to 7 points from the original offering price. "Another good sign," says Sid Bakst, portfolio manager at Weiss, Peck & Greer.

Bakst, like Marrinan, is skeptical that the recent drying up of credit market liquidity -- driven in part by worries about the market for subprime mortgages, as illustrated by this summer's collapse of two Bear Stearns(BSC Quote - Cramer on BSC - Stock Picks) hedge funds -- is over.

He notes that liquidity has only partially returned in the secondary market for existing bonds -- even with the large deal calendar back in action. He also adds that he's wary of hedge funds' month-end portfolio evaluations that will come out Aug. 15.

Even Treasury Secretary Henry Paulson carefully weighed the uncertainties in the credit market with the strength of the global economy in an interview Wednesday on CNBC. It seemed Paulson was dually charged with indicating to the markets there's no rescue plan at play for credit markets in the U.S., while reassuring them that the economy really is strong.

"We have a healthy economy ... a strong global economy ... liquidity around the world," were some of Paulson's sound bites. But they were intermingled with his austere comments that the credit markets had "a wake up call," and that the large leveraged buyout deals being financed with loans that had no covenants, or protections attached, were the "sign of a lack of discipline."

His interview was aired an hour or so after President Bush said that tax revenues should not be used to bail out mortgage lenders. Bush was referring to expectations or hopes that the caps on Fannie Mae(FNM Quote - Cramer on FNM - Stock Picks) and Freddie Mac's(FRE Quote - Cramer on FRE - Stock Picks) portfolios would be lifted, allowing the government-sponsored entities to buy up struggling mortgage products.

Optimism about Fannie, Freddie or others out there to buy up the rotten apples in the credit markets persisted, pushing the GSE's shares up 3.6% and 1.6%, respectively. Many financial stocks continued to rally as well, with Bear Stearns gaining another 3.6%, but the Paulson and Bush headlines had the markets swooning midday, and particularly the financials.

The now commonplace mantra seems appropriate once again: the only thing to count on in this market is volatility -- a daytrader's paradise and a horror show for the rest of us.