Equity vs credit: Find the discrepancy

Credit markets had a great day on Tuesday as investors took a breather after the Bear Stearns rescue. Stocks also rallied. But the two markets are living in different worlds. One is too pessimistic and the other is too optimistic. Start with credit. The spread on the Itraxx European investment grade index was as low as 20 basis points in 2007. It narrowed by that much on Tuesday, but is still at a stunning 125bps. That translates into expectations of losses almost five times higher than would ...