Steve Blitz Morning Notes

The chart below tracks 5-year CDS for JPM and GS from year-end 2006 to date. Both have started improving yet again but are still 80bps or more off their traded lows in early 2007, back when there was full faith in their credits. Through the period GS fared much worse, perhaps a sign that markets value a banking franchise more than the air out of which an investment bank's balance sheet is made.

Still, optimism in the darkest hour paid off and is paying off still. A return to pre-recession spreads is a ways off considering the over-indebtedness problems and the continued need for the Fed to back-stop everything but Treasury debt. Recent indicators of returning economic growth, however tepid the turnaround turns out to be, and the penchant for the market to be as overly pessimistic in bad times as it is too optimistic when good times are rolling, suggest that taking in 117bp/year in premium against a GS default in the next five years is not a bad bet -- apparently the market is not quite as convinced of GS invincibility as Mr. Krugman.

CDS is a tricky market fraught with margin calls if you are selling default insurance. You can still profit from an improving credit the old fashioned way -- buying GS debt, such as the GS 5.5% due 11/15/2014 trading 185bp above the generic 5-year Treasury. These recommendations come with the usual caveats about it being your money and your responsibility.