VERY interesting article..... Last Updated: 2:39am BST 14/07/2007 The two sides of Wall Street are pulling apart New York traders: âThere is this feeling you canât risk being out of the market with all this liquidity, but liquidity can dry up very fast if things go wrongâ The Dow soars to record high, despite the worst turmoil in credit markets since dotcom bust. Ambrose Evans-Pritchard reports # Dow hits record high # Dollar hits euro low as credit fears widen Schizophrenia gripped the markets as investors drove the Dow to an all-time high on Wall Street in a mood of near euphoria this week, blithely disregarding the worst turmoil in the credit markets since the dotcom bust. There was no obvious trigger for the explosive rally in equities across world bourses, beyond news that Wal-Mart sales in America have picked up a little after a grim patch. It was in any case overtaken by data yesterday showing a 0.9pc fall in US retail sales in June. Albert Edwards, global strategist at Dresdner Kleinwort, said the habits of the great bull market die hard. "We've got a slow-motion train crash in the US housing market and a drip-drip credit crunch, but every time the bad news abates for a few days people want to rush back in. There is this feeling that you can't risk being out of the market with all this liquidity, but they forget that liquidity can dry up very fast if things go wrong." Across the street in the corporate bond markets, a blizzard of downgrades by the rating agencies and near panic flight from collateralised debt obligations (CDOs) abruptly shut the spigot of cheap money that has fuelled the merger boom. The two sides of Wall Street are pulling apart The average interest rate that lower-rated companies have to pay to borrow money has jumped 50 basis points (or 0.5 percentage points) in a week, if they can get it at all. "You might call it a buyers' strike," says Daniel Toscano, loan chief at Deutsche Bank. Europe's closely watched iTraxx Crossover index - a sort of fear gauge on low-grade corporate bonds - suffered its worst ever two-day trauma, leaping from 240 to 302. It is far from clear whether the private equity giants will be able to fund some $300bn in leveraged buyouts and refinancing planned for the rest of this year, at least at a price that make the deals worthwhile. KKR is having to accept tougher terms on Â£9bn of debt needed for the Alliance Boots takeover. The days of "covenant-lite" loans that strip lenders of protection now seem over. Large parts of the CDO and relate markets have shut down as investors wait to see whether the storm will blow over. Analysts are wondering how the two sides of the capitalist system can be pulling so far apart. Thomas Stolper, a strategist at Goldman Sachs, said life was getting harder for borrowers. Three-month interest rates set by the G10 central banks have risen 210 basis points (2.1pc) since 2004 and are nearing highs seen before the dotcom recession. "Margin requirements are going up across the financial industry. Given that this directly affects the ability of the private sector to create liquidity, this could have broader implications." Even so, investors are discriminating between types of risks, rotating out of leveraged assets into Asia and other emerging markets with sturdier prospects. "The real economy remains in very good shape. When talking about risky assets, it's important to be explicit and not to simply throw them all in the same bucket," he said. The two sides of Wall Street are pulling apart Mr Edwards warns that American households are buckling under the burden of crushing debt and rising petrol prices. "The sub-prime debacle is not the problem: it is a symptom of the problem. The US economy is very close to falling out of the sky, and if that happens equity prices could fall as much as 45pc." Corporate profits are stretched 25pc above their historical trend levels in the US and 30pc above in Europe - evidence of a topping cycle. The "median" price earnings ratio of all stocks remains near record highs, in large part because private equity and leveraged buy-out predators armed with debt have bid up premiums. Bigger companies like General Electric, Exxon, Siemens are much cheaper because they are deemed too big swallow. Hence the lower pe ratios on the Dow. Teun Draaisma, head of European equities at Morgan Stanley, said equities often keep rising for a few weeks or even months after credit starts to tighten, but eventually they succumb. "The markets can ignore this for a while, but we stick with our view that there is a correction slowly playing out. The fundamentals are deteriorating. We have inflation worries, higher interest rates, and widening credit spreads," he said. He said investors had latched on to the idea that every little sell-off is a chance to buy stocks at bargain prices. While the strategy has paid off in a series of dips, the game is now changing. The bank's model predicts a stock market slide of up to 14pc over coming months, although he believes the long-term bull market for stocks remains intact. The trigger for the latest credit mayhem was last month's near collapse of two Bear Stearns hedge funds exposed to sub-prime mortgages packaged as securities, mostly CDOs. An aborted fire-sale of assets by creditors revealed that some of these CDOs are worth no more than 30pc of face value, and a few are trading at just 5pc. The suspicion is growing that chunks of America's $2,000bn of sub-prime and 'Alt-A' mortgage debt has been trading at an inflated credit-rating. Standard & Poor's is placing $12bn of sub-prime debt on negative watch last week. Moody's downgraded $5.2bn. The default rate on US sub-prime property has reached 13.8pc. The CDO market is holding its breath to learn whether the agencies will start to downgrade the A-grade investment level CDOs, compelling pensions funds and others to liquidate en masse. "Forced selling is a big concern," said Bob Janjuah, a credit analyst at the Royal Bank of Scotland. "Credit has been mispriced by a global liquidity bubble. Now the banks are just trying to offload their risk." RBS expects spreads on the lowest grade B and CCC bonds to widen another 200 to 300 basis points. "We have de-leveraging, de-risking, and de-compression. It's not the end of the world, but when this happens it tends to drag down less risky asset as well. This is not yet a credit crunch but it could become one if the central banks make any mistakes along the way."