Pullback in investor risk appetite

As problems in the housing and subprime markets have spread, investor risk appetite has shrunk. In the U.S. credit markets, investors are shunning deals with innovation and added risk. To counteract growing investor reluctance during the first half of August, central banks around the world pumped liquidity into the financial markets. “Investors Are Finally Remembering What ‘Risk’ Means,” published today, examines various aspects of the current liquidity squeeze.

“For at least two years, Standard & Poor’s Ratings Services has argued that investors were too complacent about risk,” said David Wyss, managing director and chief economist at Standard & Poor’s. “Now, they are over-reacting in the opposite direction. How much and how far they’ll over-react remains to be seen. History suggests that the credit markets will normalize fairly quickly, but that could still be months away.”

Fixed-income investors have turned to the havens of government securities and cash and cash equivalents–such as bank deposits, CDs, and plain-vanilla commercial paper–to avoid the current uncertainty. “Liquidity will re-emerge when the repricing of risk actually reaches a new level,” commented Jean-Michel Six, Standard & Poor’s chief economist for Europe.

The securitized mortgage market has experienced the greatest investor pullback, but risk aversion has extended well beyond that. “Up until a couple of months ago, companies were able to refinance with unfettered access to the capital markets,” noted Diana Vazza, managing director and head of Global Fixed Income Research at Standard & Poor’s. “Now, all that has changed. Issuance in the U.S. has fallen off a cliff.”

Although both high-quality and high-yield offerings have felt the chill in the markets, speculative-grade issuance that Standard & Poor’s rates has nearly frozen. Investment-grade offerings, while also lower, have fared comparatively better. “The market will still consider more conventional, soundly structured deals at higher rates,” said Ms. Vazza.