Sam Sez

Date: Friday, February 23, 2001

Question: "HOUSE OF CARDS: Stocks, Bonds, and Credit Classes and Quality Distinctions?"

Answer: Probably yes.

There is a substantial body of empirical research which suggests that the higher rated companies tend to receive lower financing costs. This variable may enable them to advance earlier in bull markets. This advantage helps those firms to get a headstart relative to poorer rated firms or those with less impressive expectational prospects.

Similarly, in the equity markets, firms which are viewed as having better prospects can raise funds more readily or under better terms relative to companies viewed as having inferior prospects.

For consumers, credit scoring impacts the cash flow, eventual debt servicing and purchasing capacity. It is the consumer which has the loudest voice in a free market economy. For example, their is a wide variation or spread between best rated consumers and marginal consumers in terms of credit card rates. Due to substantially different interest rates, the marginally poorer consumers are unable to make as many purchases because of higher debt servicing demands for each dollar borrowed. This principle applies to companies and countries alike.

In the context of stock and bond markets, the poorer viewed issues falter earlier in a down cycle because they are the first to feel the impact of more stringent financing conditions and terms. This, in part, may account for the relatively better performance of narrowly based Blue Chipindices relative to broader market measures or at-risk clusters.

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