Some market observers are tiptoeing around the possibility that we may be close to the bottom of the market, however it is tough to decide whether they are facing reality or actually see encouraging signs.
As I have noted on many previous occasions, it is impossible to know when the market bottoms except looking back months after it happens.
Of course, stock investors are hoping the bottom is near and that the market will begin a march back to healthier numbers.
However, there is another reason for hoping the market is near a bottom.
Typical Downturn
Typically, during a downturn, the market bottoms several months before a recession ends. There are several reasons for this, including the nature of the market to always look forward.How are we to know the market has bottomed and the economy is beginning to pull itself out of the ditch?
There are several factors to consider. One of the most important is whether the credit markets are reasonably back to normal or, at least moving in that direction.
You can get a sense, but not a definitive answer, to the credit question by keeping an eye on the Ted Spread.
The Ted Spread is the difference between the three-month LIBOR rate and the three-month Treasury Bill rates.
The LIBOR Rate
The LIBOR rate is a three-month average interest rate charged in London for intrabank loans (these are loans from one bank to another). Many of these loans are overnight or very short term.In more normal times, these rates are usually very low and reflect the confidence the banking community has in lending to other banks.
Treasury Bills and Notes are considered the safest loans an investor can make (when you buy a T-Bill or Note, you are lending to the U.S. Government, which backs its borrowing with its “full faith and credit”).
If banks are confident about credit risks, the difference between the three-month LIBOR and three-month T-Bill rates will be small. In normal times, the difference will be around 50 basis points (one-half of one percent).
This difference is the Ted Spread.
When the economy is difficult and banks become more credit adverse, the spread will widen.
During the credit crisis which began in earnest in the summer of 2008, the Ted Spread went as high as 300 basis points. On Nov. 16, 2008, the Ted Spread had dropped to 209 basis points.
When the Ted Spread begins returning to its historic numbers (about 50 basis points or one-half of one percent), it will signal that credit markets are beginning to work and banks are becoming more confident of repayment.
There can be no recovery without a functioning credit market.
You can find the three-month T-Bill rate and the three-month LIBOR rate at Bloomberg.com.
Bloomberg.com also charts the Ted Spread.
