This page has been archived and commenting is disabled.
Capital Context Update: Credit Knows, You Know
From Capital Context
Investors are shifting their preference away from equities and into IG credit - a notable shift not benefitting HY credit.
While stocks scrambled back to basically close unch, credit saw its fifth day in a row of weakness with HY wider for 10 of the last 12 days having added over 25bps during that period - all this while headlines note how low high-yield 'yields' are. Risk premia in credit are certainly indicating considerably more concern than equity risk premia and the upper chart indicates that while equities have corrected modestly here, there is still plenty of room for them to correct more.
The critical aspect of the contextual analysis we use above is that typically a risk-seeking investor class will rotate from equities into HY as a start to defensive cycles and this defends the buy-the-dips argument that it is merely short-term rotation. This is evident as we tend to see HY below IG in this chart indicating a general preference for risk over safety in the capital structure context. However, what is different about this turn is that it is IG that is being 'preferred' relatively more than HY credit. HY credit has empirically proven a great anticipatory aid to cycle turns (if one understands the non-linear cyclical relationship as we do and does not simply follow yields/spreads/equities/vol in a linear or correlation sense.
We will have much more to say (publicly) shortly on how we utilize long-term credit-equity relationships to add significant value to client's Tactical Asset Allocation decisions but for now we reiterate that we have been tactically underweight equities since mid April (we will update on any changes to this view), we also see the short-term trading context as worrisome for equities as investors shift relative preferences from equity to IG credit and avoid HY credit.
These two more tactical calls fit with the themes we have been re-iterating to readers over the past few weeks as canaries in a pending end-of-QE2 coalmine. The clear
up-in-quality trend continues
today with
HY underperforming IG
and the
up-in-capital structure trade was more idiosyncratic today
than systemic (which makes more sense to us). The
dispersion in HY credits is trending higher
as investors discriminate more effectively and diligently and as we have indicated more vociferously recently,
single-name volatility has been notably underperforming
(rising more than expected) relative to credit spreads (and also relative to index vol with a preference for protecting low beta assets while selling high beta).
IG stumbled a little more than we might expect today as HP's annus horibilis continues
and they were the worst performer in the IG16 index adding an impressive 6bps to a closing price last night of 53.5bps (a huge shift relatively speaking). This move alone in this one name accounted for one-sixth of the widening in IG16 intrinsics today (125 names remember) and biased the readings on low beta names to underperform high beta names (though excluding this there was a modest shift in favor of lower beta).
CMBX and ABX
tranches lost further ground today as the latter showed capital structure shifts indicative of expectations of higher correlation (or
more systemic problems
) while the latter was just horrible across the board following this morning's housing data.
We expect HY realized vol to pick up from its low current levels as equity realized vol has reached a relative peak in that context.
Later in the week we will publish our earnings-driven quarterly sector wrap, which details QoQ changes in sector fundamentals for credit sectors, highlights relative performance across credit/vol/equity across sectors, and indicates our point-in-time weights for sectors from both a tactical and short-term trading perspective. As a tease for that,
we note that vol has been a very notable mover in general in equities relative to spreads
(and stocks explicitly) and furthermore, equities have in general moved to considerably expensive levels (sectorally) relative to capital structure contexts. The trends are very interesting but for now we went into today overweight Financials and Materials (more a slight bias over marketweight) and underweight Staples, Industrials, Utilities, and Healthcare (with Discretionary, Energy, and Tech closer to market weight but biased to underweight). These are for trading and convergence positions and when we publish the sector wrap we will overlay our more fundamental factor models on this finding to indicate an investing decision.
Interestingly, top down shows realized
vol
for the S&P500 compared to our HY price index (an index that translates the current on-the-run credit spread into a price - avoiding the trap of yield variance) is near cyclical highs. The series is quite mean-reverting and while S&P realized vol has risen notably over the last month or so, we have yet to see HY realized vol pick up too aggressively. We suspect this is overdue and based on our cyclical model of the relationship between equity and HY vol, we would expect HY vol to be almost double its current level - implying positioning for a rise in realized vol (long delta-neutral options) makes sense in credit. We wonder when credit based variance swaps will show up?
Breadth was very weak in CDS
land at around 3-to-1 wideners and Consumer names outperformed in IG as Financials underperformed (in credit). Across our capital structure context universe, there were 60% of CDS wider and 57% of equities lower while 89% of vols were higher - so equities and credit actually in relatively more sync than normal. For the second day in a row, sectors were balanced with six seeing equity outperformance of credit and five seeing credit outperformance of equity. Financials topped the best equity performers relative to credit today - which fascinates us as when we ran our sector context model last night Financials were notably out of whack (equities under-valued relative to credit). The other end of the scale was Transports when we saw equity underperformance (on a beta-adjusted basis to credit). Aggregating across all sectors, we note that credit very modestly underperformed equity beta expectations today.
Across
quality cohorts
, it was evident that the
best quality credits outperformed relative to lower quality but equities did not seem so discriminatory
- though when adjusted for our model's debt-equity context, low quality names saw notable underperformance in credit relative to equities with crossover names more balanced. Quite notably, HP actually stayed relatively in sync across credit and equity despite the huge moves (somewhat reassuring for our model's ability to handle the non-linearities of this world) but we do note that HP's equity did underperform credit on the day (beta adjusted) - even with the relative size shift in HP's spreads. The seeking of saefty in equity land was the driver of outperformance in names today as MRK, AEP, WFC, TU, and JPM saw equities outperform credit (context adjusted) - all relatively low spread names. As a side note PMI and MBI (mortgage insurers) lost significant ground in spread land today and while the former also dived in stocks, it was less dysphoric than in spreads. The other end of the scale was also dominated by safety seekers, but this time in credit land. Perhaps it is worth noting these names down for future flight - TJX, MCD, CAT, NU, NSC, and CSX - though we note that all but NU saw their stock prices drop on the day.
It seems all that whining the last few weeks about macro data weakening is starting to catch up with the US and the fact that CAT lost decent ground today adds some concern for global growth expectations (no matter what Hatzius has to say). Remember the Citi Econ Surprise Index divergence? Well, equities are starting to play catch up and credit once again signaled it early in context.
Europe
Still more chatter from Papandreou and his buddies that restructuring is off the table, will cost too much, that surpluses are the primary goal, and everything will be alright if we would just shut up and trust them all (as the elites continue to prove themselves trustworthy). SovX stumbled wider for the first time in seven days as did most of the major European sovereigns themselves. Two things are of note: 1) SovX and its intrinsic value had converged notably in the previous two weeks or so (the skew narrowed) and we suspect much of the compression in individual names was thanks to some index arb pressure which may have finally ebbed today; and 2) the ban on naked shorts on sovereign debt was lifted modestly with a change of language to 'reasonable expectations' that the debt will be owned when needed. Why is this important I hear you ask?
Greek government bonds have outperformed CDS as basis traders return and provide some support at the margin.
We have been on the bandwagon recently, as biased as we may appear, that a ban on sovereign shorts which would inevitably lead to a ban on sovereign CDS will cause more damage than help. This may not be the populist argument - especially knowing how naughty those nasty CDS traders can be but the market speaks for itself and today's shifts in cash and synthetics should show you why. The only people with any real appetite for GGBs is basis traders (or very short-term traders but these guys are hardly the marginal buyer supporting spreads) since the ECB stopped buying. This is extremely evident in the chart opposite. This is the spread between the cash bonds and the CDS market - the so-called basis - in order to execute this trade you buy the bonds and buy credit protection (there is a lot more wonderful nuance but this is the main point). Today, as concerns over the viability of CDS were lifted modestly and further restructuring efforts seem gone for now, we saw GGBs rally 17bps over Bunds (even as CDS smashed wider) - this is a huge compression in the basis, and indicative of basis traders being more comfortable stepping back in.
In fact, based on our data (as the BBG screengrab has not been updated for today's end of day yet), the basis has compressed to less than 50bps - but we will wait for settlement to clarify that completely. Again we hope this analysis helps put in context when we see headline comments on the compression in Greek bond spreads. Interestingly, given the relatively large size of the basis compression today, the rally in GGBs, and the fact that Greek sovereign CDS are denominated in USD remember - maybe some of the EUR strength/USD weakness today can be assigned to hedgers managing that floating stream of USD payments to keep the basis trade more in line with the EUR denominated greek bond interest payments.
Away from sovereigns, things were not prettty in corporate spreads either with Ex-Financials widening 1bps while FINLs widened 4bps. The triangle of FINLs-to-Main-SovX has compressed recently (as we have explained and may be part to blame for technical strength in SovX) and the differential between Main and FINSEN is now within 10bps of 'fair' given SovX - in this new regime. We remain of the opinion that this trade has legs (FINs-Ex-Fins decompression) but for a perhaps cleaner trade use Main Ex-Fins vs Fins which has more room to decompress in our opinion as you avoid the beta overlap.
Asia
ITRX Japan managed a 2bps compression overnight as AXJ only 0.5bps bringing our trade near its first profit target of 10bps differential. Australia was unch as in general was the Asian sovereign index. Banks in Asia in general performed well - though nothing incredible on the day - apart from Sumitomo which was among the worst performers as Telecoms names softened in general.
Index/Intrinsics Changes
CDX16 IG
+0.67bps to 90.17 ($-0.02 to $100.36) (FV +0.35bps to 89.4) (69 wider - 44 tighter <> 56 steeper - 67 flatter) - No Trend.
CDX16 HVOL
+0.7bps to 149.6 (FV +0.88bps to 149.72) (20 wider - 8 tighter <> 12 steeper - 18 flatter) - No Trend.
CDX16 ExHVOL
+0.66bps to 71.4 (FV +0.17bps to 71.04) (49 wider - 47 tighter <> 52 steeper - 44 flatter).
CDX16 HY
(30% recovery) Px $-0.3 to $102.39 / +7.2bps to 441.5 (FV +9.8bps to 429.49) (89 wider - 9 tighter <> 31 steeper - 68 flatter) - Trend Wider.
LCDX16
(70% recovery) Px $-0.13 to $101.375 / +3.33bps to 250 - Trend Wider.
MCDX16
-1.03bps to 124.725bps. - No Trend.
ITRX15 Main
+1.58bps to 98.08bps (FV+0.3bps to 100.05bps).
ITRX15 HiVol
0bps to 133bps (FV+0.08bps to 132.64bps).
ITRX15 Xover
+4.42bps to 357.92bps (FV+1.24bps to 344.69bps).
ITRX15 FINLs
+4bps to 139.75bps (FV+1.4bps to 137.43bps).
DXY
weakened 0.15% to 75.36.
Oil
rose $0.39 to $97.76.
Gold
fell $2.6 to $1486.7.
VIX
fell 0.69pts to 17.55%.
10Y US Treasury yields
fell 3.1bps to 3.12%.
S&P500 Futures
gained 0.11% to 1327.
Spreads were broadly wider in the US as all the indices deteriorated. IG trades 2bps tight (rich) to its 50d moving average, which is a Z-Score of -0.8s.d.. At 90.17bps, IG has closed tighter on only 54 days in the last 611 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 9.4bps wide (cheap) to its 50d moving average, which is a Z-Score of 0.8s.d. and at 441.5bps, HY has closed tighter on 77 days in the last 611 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 5.1bps (or 71% of today's move). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 6.9bps, and stocks outperformed IG by an equivalent 0.6bps - (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 Hewlett-Packard Company (+4.72bps) [+0.04bps], Toll Brothers, Inc. (+4.5bps) [+0.03bps], and XL Group Ltd. (+4.26bps) [+0.03bps], and the best performing names were RR Donnelley & Sons Company (-3.39bps) [-0.02bps], Kroger Co (-2.62bps) [-0.02bps], and McDonald's Corporation (-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 PMI Group Inc/The (+154.21bps) [+1.14bps], Radian Group Inc (+84.21bps) [+0.73bps], and MBIA Insurance Corporation (+66.76bps) [+0.45bps], and the best performing names were Temple-Inland Inc. (-3.39bps) [-0.04bps], Liz Claiborne Inc. (-2.74bps) [-0.03bps], and GenOn Energy, Inc. (-1.41bps) [-0.01bps] // (absolute spread chg) [HY index impact].
»
- advertisements -
IMHO...the respect for real money has started. Traders/ investors have brought the ES down. Now they are reacting to Obama / Geithner counter attack.
You know that these facsist / socialists will do Anything to maintain power. USD to confetti status ...who cares, as long as they control the joy sticks.
Socialists never leave office w/o violence, because they know they are fedreal spending parasites, and once the populace knows... they are part fo history.
History is being written and it ain't gonna be pretty. That's wny ZH has gone from fringe to almost mainstream.
better be stockin up on gold and silver cause the fartin is over and it's about time for the proverbial shit to hit the fan..........
My Google translator blew a fuse trying to translate this jargon. I tried Ebonics, Pidgeon, Esperanta, Irish, etc. Nothing worked. Computer just smoldered.
Author, please just tell us whether to BTFD or not.
uhh, umm, HY? IG?
(this site needs a thesaurus)
uhh, umm, HY? IG?
(this site needs a thesaurus)
High Yield (junk bonds)
Investment Grade (good bonds)
Thx. Speaking of Europe, Spanish CDS coming down nicely.
O/T: I was wondering if there are any ZH readers that used to trade treasuries back in the 70s. I'd like to talk about your experience if you are willing.
HONG KONG (Commodity Online): The Hong Kong Mercantile Exchange (HKMEx) has received authorisation from the Securities and Futures Commission and will make its trading debut on May 18, 2011 with the 1-kilo gold futures contract offered in US dollars with physical delivery in Hong Kong.
thats now