Credit Market Says: Don’t Buy Stocks Yet! Part I

Since July 15 when U.S. markets hit another intermittent low amid the ongoing credit crisis, the Dow Jones Industrials Average (Dow) has gained 7.2%.

But over the same period the most important credit indices have posted declines while others have logged marginal gains. Overall, the broad trend in credit has not been bullish since mid-July. This tells me that stocks are luring more investors into another bear market trap.

Since the onset of the credit squeeze last August, stocks have staged two bear market rallies - the first last September and another one in late March. Both rallies ended badly for investors.

The last bear market rally following the Bear Stearns Cos. bailout was actually supported by a broad-based decline in riskier credits. But that 10% gain for stocks from late March through late May also proved dangerous. In June, the S&P 500 Index plunged more than 8%. In fact, that was the worst June for the S&P 500 since 1930.

Nevertheless, it’s important to gauge what credit indicators are telling us now so we can at least feel more confident dipping our toes back into the stock market.

Lending rates, as defined by LIBOR, which sets the standard for over US$1.5 trillion worth of global funding remains elevated. It’s still 80 basis points above the Federal Funds target rate.

The same is true in Europe where EURIBOR sits at 4.96%. That’s significantly above the European Central Bank’s (ECB’s) base rate of 4.25%.

These lending rates have not eased since June and continue to paint a bad picture for global cross-border lending or the lack of inter-bank liquidity. Central banks, despite pumping the credit markets with hundreds of billions of dollars or euro since last summer, still can’t ease LIBOR or EURIBOR.

LIBOR remains my greatest concern followed by mortgage rates.

Tune in tomorrow and I’ll show you exactly how the credit markets reacted to this past week’s stock market rally.