American credit market outlook

Credit spreads of US financial companies may outperform in the second half of 2008, though there is no rush to take long positions in the credits as the first half of the year still threatens to be weak.
Meanwhile some cyclical companies, which have been considered among the safer credits, could underperform if weakness in the US economy extends to global markets and the dollar overcomes some recent weakness. "The credit markets in 2008 will look to the financial space for direction, or at least stabilisation, before greater scrutiny can be placed on nonfinancials," Morgan Stanley analysts including Greg Peters said in a report on Friday.
"Given the nature of this financial-centric credit crisis, nonfinancials will not stabilise unless financials do. And we believe this time is near," they said. "It's going to get worse before it gets better in the financial space," the bank said. "But ultimately, we believe the financial sector will outperform both Treasuries and nonfinancials by this time next year."
Companies including banks and brokers have reported losses from writing down the value of mortgage related securities, and this is expected to continue into 2008. The need to sell new debt to shore up their capital base is also hanging over their credit valuations.
"There doesn't appear to be any technical relief in sight given there is going to be a constant stream of issuance in 2008 with deals that will generally be as large as the market will bear," said Sid Bakst, portfolio manager at Weiss, Peck and Greer in New York. "The fundamental picture is also not clearly favourable with the cloud of further potential writedowns and capital shortfalls hanging over the sector," he said.
With relatively wide spreads, opportunities to take long positions will exist, but investors will need to seek out which credits represent good value. "It remains to be seen whether these wide levels are indeed cheap levels," Bakst said. "There will certainly be selective buying opportunities in the space throughout the year. You just want to pick your spots and take advantage of those deals that come with unusually large concessions."