Debt Worm Turns for a Day

As quickly as hedge funds can be the markets' foil, they can come to its rescue. Or, so investors seemed to think Monday.

It was the collapse of two subprime-focused Bear Stearns(BSC Quote) hedge funds in June and the sum total of their losses announced earlier in July that really sent the credit markets swerving off their rails.

But the credit markets and the stock market were able to bounce Monday mostly on news that hedge funds, among others, are bottom-fishing for opportunities.

The Dow Jones Industrial Average gained back 0.7%, or 92.84 points to close at 13,358.31, while the S&P 500 added 1% to close at 1473.91 and the Nasdaq Composite finished the day up 0.8% at 2583.28.

After widening out by another 60 basis points in early trading Monday to kiss a recent risk premium high of 602 basis points, the high-yield bond market, as measured by its related CDX derivatives index, snapped back on news that hedge fund Citadel Investment Group is buying the soured credit holdings of hedge fund Sowood Capital, which manages about $3 billion. The CDX index closed Monday at a risk premium of around 500 basis points.

Sowood has investments in stocks, bonds and convertible bonds; Citadel is buying the credit portfolio in a transaction that The Wall Street Journal reported is most likely "worth hundreds of millions of dollars."