Capital Context Update: All Asunder but Credit Calm

From Capital Context

Full ETF Arb position exited at solid ~12% return intraday - velocity was more driver of exit than convergence.

Credit spreads decompressed modestly today in IG and HY as almost every other asset class saw dramatic moves and equities saw their largest day-to-day underperformance of credit since 3/10 (based on our relative-value models) - even more so than last Thursday's underperformance.

We commented earlier in the day on the velocity of convergence today and exited half our ETF Arb position by
lunchtime
and hit our adjusted target of $16 mid-afternoon for a very rapid ~12% return (unlevered).

We have been aggressively discussing our view of equity being over-priced relative to credit and why we did not think this was entirely due to any capital structure shift (intentional releveraging) for a while now and it is certainly the case that recent events have converged this relationship but there is still a considerable way to go. We remain short-term traders of the ETF Arb position (opportunistic) but from a tactical asset allocation perspective up-in-quality and up-in-capital structure are the way to go still.

Credit
was notably calm today relative to everything else and we suspect that our comments from a week or two back on the shakeout in credit (likely due to heavy short gamma exposure) was done and the exaggeration that is evident from these exposures has certainly been removed for now. Equities perhaps have some of this as skews remain steep and everyone and their mum seems to like selling short-term vol but more than anything else, we suspect this is simply more USD related (something we have pointed out again and again as equities rallied).

The S&P 500 in constant USD terms Year-to-date seems to have found resistance at +4% and support at unch.

The chart opposite shows an interesting relationship (at leats interesting to us). In constant USD terms, S&P returns YTD have seen strong resistance at around 3% YTD and support at unch. Obviously this is simple data-mining and we have little to add in terms of comprehension of this but it certainly does provide some food for thought as far as the overall sentiment of the market.

Depending on your measure or approach, we see equities 10-20% over-valued relative to credit (or inverting the relationship, equities/vol/skews are implying 50bps or so of compression in HY spreads and 6-7bps in IG). HY's relative cheapness is its narrowest in three weeks (but still has plenty of room to run) and is definitely not seeing the same kind of 'help' that IG is seeing in this relatively risk-averse environment. We remain very confident of our HY-IG decompression trade and for those who cannot execute in CDS or bond land, then our HYG-LQD (1.2x beta) trade is holding in well so far from our entry around $40.3 from last week (also current level and warrants entry).

S&P futures clung to JPY crosses all day (note the divergence between JPY today and rest of DXY components around the end of Europe).

European spreads compressed a little in sovereign land but
FX
was active as it was the EUR (that lost 1.5% versus the USD) that meandered weaker only to be smashed as Europe closed - pushing DXY back above 75 and EUR <1.42. Its interesting to note that silver and oil really started their slip post the inventory numbers and the EUR also accelerated then - did some European fund choke?

The one item that is maybe not immediately apparent is that JPY crosses lost serious ground today (carry trade unwinds) and this was as much an anchor around S&P's neck as any other fundamental news item one can imagine.

Clearly the major focus for many was the
commodity complex
once again and while all the majors were losing ground pre-open (china inflation pushing more concerted slowdown?), the move accelerated as the day session opened and once again as Europe closed.

The red blocks show similar relative downdrafts as Silver massively underperformed today and copper also!

The shift today was on a scale in silver at least that we saw during last Thursday's liquidations and while there was no margin hike in silver today, after hours saw CME raise RBOB and spread margins dramatically (the latter seems like a shot across the bows of the big oil firms if we really step back and squint).

Copper went largely unnoticed from most headlines from what we saw but had a very significant move (which we assume fits more with the China slowing thesis than simply momentum).

VIX
had a relatively quiet day too which surprised many but it was more of the same as the term structure steepened and skews steepened and implied correlation rose - all rather notably negative from a sentiment perspective. We have ben pointing out the rise in single-name protection relative to index protection recently and today's calmness at the index level vol suggests some comfort in that thesis (though one can't help but note how low VIX is relative to where the S&P is trading (about 2pts lower than empirically expected). This difference could be explained by short-term short correlation bets that we have been harping on about (remember our tri-partite market perspective; FINS, Energy/Basic Materials, and Others) which appears to be hanging around more recently.

Contextually
, most of today's relative under-/over-performance was due to equity or vol moves and not credit (if that makes sense?) as only around 4% of our universe of CDS saw moves greater than +/-3bps. 50% of CDS were wider while 85% of stocks in our capital structure universe were lower and 97% higher in vol (single-name vol notably outperforming - increasing more - than index vol).

Equity underperformed credit in all sectors today with Fins, Basic Materials, and Energy worst of all.

High and low beta names were pretty even in credit with very slight outperformance of higher beta but high beta equities notably underperformed on the day. Every sector saw relatiev credit outperformance (based on our model's expectations given vol/equity moves) which is something we have not seen in a while with Consumer Non-Cyclicals the most in line and Energy the most out of line (hammered considerably more in equities than credit) along with Basic Materials (and followed closely by financials).

Moves in single-name vol had a clear theme today with low quality rising notably more than higher quality but most of the crossover space was similarly bid in vol. Credit relative to equity was unclear today from a theme perspective but we do note relatively significant net buying in IG and modest net selling in HY secondary bond trading (basedon TRACE).

Bottom-up, AVP, TU, HRB, DELL, DHI, MCD, and JNJ saw the largest credit underperformance relative to our expectations from their equity/vol moves today (and we note builders were notably at the top of this list as we saw ABX and CMBX tranches continue recent trends of weakness and long correlation). At the other end, where credit moves were notably better than expected given the shifts in equity and vol, FCX, APA, HAL, MBI (earnings), EP, CVX, and VLO (see the theme?) topped (or bottomed) the list.

On a slightly different tack, some clients have asked us about the
Muni
market - an area we have discussed in terms of startegic and tactical allocation (as opposed to name-by-name which is out of our expertise). The particular focus was on Muni curves and how steep they were. While MCDX is relatively illiquid off the run, execution is possible and for illustration we show the spectrum of MCDX spread levels across maturities.

Muni CDS (MCDX) spread curve suggests steepeners for roll-down for those who remain positive.

There is certainly a bifurcation in the curves over and under 5Y maturities which suggests (given our somewhat sanguine view of Munis top-down) steepeners as a play on roll-down (something we have been asked about recently quite a lot). The only thing holding us back from strong conviction is the relative valuation of MCDX to IG (which is narrow again) and the concern of another flare-up in European sovereigns which seem to have notable contagion linkages with MCDX (we have written on this before).

If investors are less than uber-bullish on Munis then the steepener - at least for a few months to next index roll could be warranted (MCDX 5s10s steepener DV01-neutral) but large moves will hurt so keeping an eye on European auctions and maturities (and ECB/IMF meeting schedules) is probably wise. We aplogize for the somewhat less than normally strong view here but at least we are comfortable saying we don't know what we don't know.

Bottom line
, today's relative calm in credit is not a signal of confidence as much as the rest of the world's asset classes catching up to its signals. Our old perspective that credit anticipates and equity confirms seems in play and actionable ideas vary based on timing and ability to execute. The shifts in vol regimes between FX, rates, spreads, and equities are very different during periods of excessive Fed easing (QE) and we expect some reversion as QE2 is wound down - though Fed heads want to keep you guessing with their frantic chatter that in the end it will all be alright - sounds rather like how I talk to my kids?

Index/Intrinsics Changes

CDX16 IG
+0.75bps to 89.25 ($-0.03 to $100.4) (FV +0.42bps to 89.09) (74 wider - 27 tighter <> 47 steeper - 73 flatter) - No Trend.



CDX16 HVOL
+0.3bps to 148.3 (FV +0.94bps to 148.97) (23 wider - 6 tighter <> 11 steeper - 19 flatter) - Trend Tighter.



CDX16 ExHVOL
+0.89bps to 70.6 (FV +0.23bps to 70.88) (51 wider - 45 tighter <> 59 steeper - 37 flatter).



CDX16 HY
(30% recovery) Px $-0.19 to $103 / +4.6bps to 426.9 (FV +2.24bps to 415.84) (74 wider - 20 tighter <> 38 steeper - 62 flatter) - Trend Tighter.



LCDX15
(70% recovery) Px $-0.19 to $101.375 / +4.77bps to 242.09 - No Trend.



MCDX15
+3.77bps to 121.765bps. - No Trend.



ITRX15 Main
-0.25bps to 96.75bps (FV-0.68bps to 99.41bps).



ITRX15 HiVol
-0.5bps to 133.75bps (FV-0.79bps to 133.18bps).



ITRX15 Xover
-0.5bps to 355bps (FV-0.4bps to 344.27bps).



ITRX15 FINLs
+1.75bps to 137bps (FV-0.44bps to 134.75bps).



DXY
strengthened 0.96% to 75.33.



Oil
fell $5.67 to $98.21.



Gold
fell $14.83 to $1501.45.



VIX
increased 1.04pts to 16.95%.



10Y US Treasury yields
fell 5.4bps to 3.16%.



S&P500 Futures
lost 1.32% to 1335.9.

Spreads were broadly wider in the US as all the indices deteriorated. IG trades 2.8bps tight (rich) to its 50d moving average, which is a Z-Score of -1.1s.d.. At 89.25bps, IG has closed tighter on only 38 days in the last 607 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 11.5bps wide (cheap) to its 50d moving average, which is a Z-Score of -0.5s.d. and at 426.91bps, HY has closed tighter on only 35 days in the last 607 trading days (JAN09). Indices typically underperformed single-names with skews widening in general.

Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY underperformed by around 1.7bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 15.4bps, and stocks underperformed IG by an equivalent 3.5bps - (implying IG outperformed HY (on an equity-adjusted basis)).

Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were MDC Holdings Inc (+4.5bps) [+0.03bps], Computer Sciences Corp. (+4bps) [+0.03bps], and Expedia, Inc. (+3bps) [+0.02bps], and the best performing names were Safeway Inc. (-3.5bps) [-0.03bps], GATX Corporation (-3.5bps) [-0.03bps], and Freeport-McMoRan Copper & Gold Inc. (-2bps) [-0.02bps] // (absolute spread chg) [HY index impact].

Among the HY names in the US, the worst performing names (on a DV01-adjusted basis) were K Hovnanian Enterprises, Inc. (+48.26bps) [+0.35bps], Dynegy Holdings Inc. (+39.96bps) [+0.32bps], and Eastman Kodak Co. (+24.51bps) [+0.18bps], and the best performing names were MBIA Insurance Corporation (-129.99bps) [-0.91bps], Rite Aid Corp (-24.41bps) [-0.21bps], and Level 3 Communications Inc. (-13.35bps) [-0.13bps] // (absolute spread chg) [HY index impact].

Comments

[mynhair]

S&P only 10-20% overvalued?  What?

NFLX must be in it, somewhere.

Hell, throw in all RT's momo stocks.

Seems more like 50% overall.

But what the hell do I know?