As housing woes spread to the corporate credit market, the economic outlook is sure to decline. Just how much further down do we have to go? News from credit markets and economic data on July 26 toppled the “wall of worry” that stocks had been climbing on the way to record highs earlier in July reports Business Week. With the Dow falling 311.5 points and the Standard & Poor’s 500-stock index off 2.33%, how much worse can things get before they get better?

 

The problem for those making predictions is that crises in the debt and housing markets are playing out in slow motion. The full effects of a credit crunch or an even deeper housing slowdown aren’t yet clear.

 

On July 26, the idea that worries about subprime mortgage loans really were spreading to corporate debt seemed to sink in for investors. That threatened the boom in mergers and acquisitions that has fueled the market’s rally. The renewed worries were sparked when traders learned two big private equity deals, the buyouts of Chrysler (DCX) in the U.S. and Alliance Boots in Britain, were having trouble finding financing from public debt markets.

 

If bond investors are staying away from riskier deals, says Bill Larkin, portfolio manager of fixed income at Cabot Money Management, it could lead to a spike in the interest rates for all riskier debt. He warned of “a drastic re-pricing of risk, which is going to have an impact on anyone who needs to borrow money.”

 

This could threaten the cheap, easy money that private equity firms have relied on to make M&A deals. More than $1.5 trillion in M&A was announced in the second quarter, up from $763.4 billion the year before, according to the research firm CapitalIQ (which, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP)). Higher rates could also slow down corporate stock buybacks, another pillar supporting the stock market rally. The July 26 sell-off hurt all stocks, but particularly the small-cap companies more likely to be bought out by private equity investors, says Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research.

 

Many forms of debt are thinly traded, so it’s hard to get a handle on how high interest rates will go. Also, private equity may delay deal financing until the fall, when firms hope that the debt markets will have stabilized.

 

Read it here: http://businessweek.com/investor/content/jul2007/pi20070726_782859.htm?chan=top+news_top+news+index_investing