I think the equity market is on the verge of an extremely sharp correction. This morning General Motors forecast a first-quarter loss and cut its full-year estimate because of lower vehicle production and weaker than expected sales in North America. GM said it will lose $1.50 per share, compared with its earlier forecast of break even to a small profit.
While you might ask "so what?" given that GM has been in trouble forever, the company’s bonds are the real problem. Right now the bonds are one step above junk – BBB. Most likely S&P will downgrade the bonds to junk on this announcement. This will force all the investment grade bond managers who own GM bonds to sell which will put pressure on the overall bond market. It will also spook international investors who have been pouring money into the US corporate bond market and keeping interest rates low. This doesn’t address what could potentially happen if GM has to declare bankruptcy, which, I think, has a high probability of occurring in the next couple of years.
Already this morning, the spreads on GM bonds are widening – I think this will spread to all corporate bonds. And this could be the inflection point that will finally cause US interest rates to rise.
The last time interest rates rose significantly is in March of 2004 when the 10 year treasury went to almost 5%. That small rate rise brought the equity market to a standstill for the majority of 2004. I think a similar move in bonds to 5% will cause equities to sink given that leadership groups like financials and homebuilding are tied to interest rates very closely.
The market has been able to fight off a lot of headwinds – rising oil, rising commodities, Iraq, etc, – but this might be final issue that pushes the market over the edge.