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Capital Context Update: Observations and Other Greeks
From Capital Context
S&P futures appeared to be in a world of their own today relative to other assets though credit in general did follow suit.
While stocks seemed in a world of their own today relative to Treasuries, FX carry, PMs, oil, and even the USD, they managed to make solid gains amid above average volume (which admittedly came in large chunks and more during the selloffs) following a series of dismal macro prints this morning. A last hour burst in S&P futures, which seemed entirely without news or co-integrated synchronicity on huge volume surprised many but quickly rolled over after taking out overnight highs and making new multi-year highs leaving the S&P futures at yesterday's day session highs and overnight peak volume price.
All of this is interesting but for the first time in well over a week, credit outperformed stocks in IG and while HY was tighter close-to-close, it notably underperformed IG (on a beta-adjusted basis) and was pretty much in sync with stocks (again beta-adjusted). This up-in-quality theme is starting to really take hold and while we have talked about stocks being notably overpriced relative to credit for a while now, it is the velocity of moves in IG over the last three days that makes us wonder if there is a little more to this than simple fundamental safety preferences (though once again we note TSYs saw a bull steepening again today in the face of equity strength).
We have been discussing the somewhat unusual behavior in credit and equity markets with clients for a few days and rather than add lengthy prose to what is already a relatively complex topic, we point to a couple of charts and
observations
that are indicative of something we think is playing out in credit derivative land. This is a little complex but worth the trip we promise.
IG Credit Options are pricing implied relative realized vol near recent channel lows - suggesting some covering is underway.
First of all, the
up-in-quality trade is here
, no doubt about it and while several higher spread and higher beta names did outperform today, secondary bonds and CDS markets showed another day of huge relative volume net buying IG relative to HY today.
Second, when spreads and vol in general (realized and implied) drop to very low levels (and HY all-in yields) we see
sell-siders start to push 'other' instruments
. In the case of credit we typically see a plethora of tranche or options strategies that either add carry or provide levered exposure to a view or at the margin are hedge vehicles (though expensive at currrent levels).
The skew in IG Credit options volatility just spiked off relative high levels and further suggests some covering of downside protection at expensive levels.
The point is that
investors shift from seeking yield via levered firms (so-called high yield credits) to seeking yield via levered instruments
- make sense so far? Instead of reaching down the quality spectrum for return/yield, investors are drawn to relative safety but lever that relative safety. This might be a dealer willing to margin a cash-CDS basis trade at 50-to-1 or more simply, an end-user with a positive view on IG credit using options to position that view as opposed to outright credit.
The increase in tranche/options activity, in what is admittedly a liquid but really not incredibly liquid market, adds some notable hedge risk to the equation for dealers and end-users alike. If you are still with us, then here is the money-shot, the velocity of the moves in IG recently (and gappiness) suggest a significant amount of gamma in the system. We have seen this before and its impacts - exaggerating swing trades - i.e. the need to sell more protection as spreads tighten and vice versa to remain delat hedged.
IG Credit pulled back to its 50-day average for the first time in six weeks.
The reason we think this is relevant is that we have reached some empirically interesting levels in terms of volatility carry (the gap between realized and implied vol) as well as the credit option skew (much like in stocks the downside to upside skew is steep in credit). IG and HY credit are back to early March levels of spread and the S&P is 50pts higher and VIX 5pts lower in the same context as credit!
While we remain a strong supporter of the up-in-quality trade, we suspect that the gamma impact of the rise in credit options/tranche exposures (the latter seeing more tail risk hedging and correlation bets recently) may have exhausted the index-level shifts for nw (especially in IG) as it compressed its skew to its fair-value very dramatically today.
HY Credit also pulled back for the first time in six weeks below its 50-day average after finding resistance at the May10 tights.
IG and HY both broke through (marginally) their 50-day average spreads today for the first time in over six weeks and as you can see from the charts adjacent, typically it has acted as support/resistance rather than a trend extension in recent months.
Today saw single-name credits positive but breadth was not crazy good at around two tighteners to each widener and the skew compression (the index tightened wellover 2bps while the underlying compnent-based index value less than 0.7bps) was the largest since series 16 of IG started trading - again suggesting index technicals (the gamma stuff we mentioned above) as opposed to broad strength.
Curves were almost perfectly balanced with flatteners slightly outnumbering steepeners in single-names and again the technicals that we suspect are impacting the most liquid 5Y points of HY and IG caused the index to flatten in 3s5s also. To add some further spice to this comment, the off-the-run indices that are most dominated by tranche trades (IG9 and HY9) outperformed quite notably also. The bottom line from all of this is that the trend of credit compression has been exaggerated in recent days via what we think was a heavy gamma hedging need, we would caution of reading much into HY compression here since single-names did not live up to expectations and its move was far less than we would have expected given IG's move. IG, on the other hand, is very tight here and while we believe HY-IG decompression still works we would be much more selective in our up-in-quality trades (i.e. focus on idiosyncracies and not systemic bets for now). OK, now you can breathe and relax ahead of Bill-and-Kate's Big Day Out.
Away from stocks and credit,
TSYs
behaved how we would have expected given the low growth print - yields dropped and it seems like we saw some USD repatriation (certainly the Brazilians were buying USD) into safety.
VIX
slid in line with the rise in stocks but the skew steepened and implied correlation rose intraday but was off its highs by the close (this measures the demand for index protection over single-name protection).
Based on our equity, credit, vol contextual framework, we see Fins and Transports underperforming in credit and Cyclicals and Healthcare outperforming today.
Contextually
, 29% of our broad credot universe was wider on the day, almost in line with the 33% of stocks lower and a notably lower 67% of vols higher on the day. Low beta stocks saw CDS outperform relative to high beta (again up -in-quality rotation), and low beta stocks also outperformed on average in stocks relative to high beta today. Low beta vols rose more than high beta - which we reiterate seems as much about protecting solid companies as it is about selling high-flyers (month-end perhaps?).
Financials and Transports outperformed in stocks over credit today (relatively speaking from our contextual framework) and the former admittedly was a surprise given our recent comments but one day does not a trend make. Consumer Cyclicals and Utilities (and Energy) saw the best relative credit performance on the day in the context of equity and vol performance.
All-in-all, a high volume day in credit with up-in-quality continuing. Stocks seemingly bullet-proof but HY risk-on sensibilities not buying into that. IG compression may stall here since the derivative-driven exaggeration of trend may have peaked, though we still see HY-IG decompression (systemically and idiosyncratically) as the play here. Was the financials rush in stocks today, month-end window dressing driven - it remains cheap in stock to credit but we believe concern is warranted in equity relative to credit here.
Europe
Overnight saw the EUR touch 1.4882 before rolling over (and a sub-73 DXY). More compression in SovX, now very notably tight to its fair-value, narrowed the link between itself, FINLs, and Main as w enote modest compression in Spain, Ireland, and Portugal while Greece limped wider (as the cash-CDS basis we mentioned yesterday was wide enough for players to step back in and compress it by 123bps on the day).
Financials considerably outperformed non-financials on the day but remain wide of their differential from just a week ago still at around 42bps. Senior-Sub financials differential fell below 100bps for the first time in a week also.
Asia
Japanese corporates underperformed AXJ today by around 1.5bps as the latter (Asia Ex-Japan) compressed and recovered its loss from Wednesday. AsiaPac sovereigns compressed also as did Japan but Australia outperformed of all the indices - rallying 1.5bps or so on the day helped by the banks (yes against our position).
Index/Intrinsics Changes
CDX16 IG
-2.26bps to 89.49 ($0.09 to $100.39) (FV -0.62bps to 88.85) (33 wider - 78 tighter <> 55 steeper - 68 flatter) - No Trend.
CDX16 HVOL
-2bps to 150 (FV -1.58bps to 146.14) (13 wider - 15 tighter <> 10 steeper - 20 flatter) - No Trend.
CDX16 ExHVOL
-2.34bps to 70.38 (FV -0.44bps to 71.47) (21 wider - 75 tighter <> 50 steeper - 46 flatter).
CDX16 HY
(30% recovery) Px $+0.25 to $103.095 / -6bps to 424.4 (FV -2.34bps to 415.22) (31 wider - 63 tighter <> 60 steeper - 40 flatter) - Trend Tighter.
LCDX15
(70% recovery) Px $-0.06 to $101.375 / +1.53bps to 229.22 - Trend Tighter.
MCDX15
+0.13bps to 139.125bps. - Trend Tighter.
ITRX15 Main
-1.41bps to 96.53bps (FV-1.92bps to 99.24bps).
ITRX15 HiVol
-1.78bps to 135.72bps (FV-2.18bps to 132.78bps).
ITRX15 Xover
-8.26bps to 353.24bps (FV-4.8bps to 345.71bps).
ITRX15 FINLs
-4.38bps to 130bps (FV-4.63bps to 132.12bps).
DXY
weakened 0.56% to 73.11.
Oil
is unchanged at $112.76.
Gold
rose $8.4 to $1535.75.
VIX
fell 0.73pts to 14.62%.
10Y US Treasury yields
fell 4.5bps to 3.31%.
S&P500 Futures
gained 0.28% to 1354.8.
Spreads were tighter in the US as all the indices improved. IG trades 2.6bps tight (rich) to its 50d moving average, which is a Z-Score of -1s.d.. At 89.49bps, IG has closed tighter on only 35 days in the last 598 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 17.3bps wide (cheap) to its 50d moving average, which is a Z-Score of -0.2s.d. and at 424.43bps, HY has closed tighter on only 27 days in the last 598 trading days (JAN09). Indices generally outperformed intrinsics with skews mostly narrower.
Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY underperformed by around 6.9bps (or 115%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 0.4bps (~ 7%), and stocks underperformed IG by an equivalent 1bps (~ 47%) - (implying IG underperformed HY (on an equity-adjusted basis)).
Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were CenturyLink, Inc. (+11.21bps) [+0.09bps], RR Donnelley & Sons Company (+3.24bps) [+0.02bps], and Vornado Realty LP (+1.68bps) [+0.01bps], and the best performing names were Constellation Energy Group Inc. (-41.5bps) [-0.33bps], FirstEnergy Corp (-9.16bps) [-0.07bps], and Viacom Inc. (-4.75bps) [-0.04bps] // (absolute spread chg) [HY index impact].
Among the HY names in the US, the worst performing names (on a DV01-adjusted basis) were Eastman Kodak Co. (+109.1bps) [+0.84bps], Liz Claiborne Inc. (+34.9bps) [+0.32bps], and McClatchy Co./The (+23.46bps) [+0.2bps], and the best performing names were Dynegy Holdings Inc. (-66.95bps) [-0.56bps], iStar Financial Inc. (-54.5bps) [-0.52bps], and GenOn Energy, Inc. (-25.99bps) [-0.25bps] // (absolute spread chg) [HY index impact].
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this is above my head, but I trade threasrues (30 year) and the inverse TBT). weird shit going on because not related to stocks. the best I can figure is that stocks relate to current earnings, and by the bonds they should drop in the future. it would be nice to have an idiots vew of what you say. I see an strangeness, but I don't understand the language you use to make conclusions.
The fact that equities are moving higher as investment-grade bonds are moving higher sticks a bone in my craw; gets my spider-sense tingling, so to speak.
It's beginning to smell like the biggest pump-and-dump in the history of the world. Money is moving from riskier assets into safer ones, even as money is appearing to move into riskier assets as well, including gold and silver. From what I can gather from the piece (and please correct me if I am wrong...), is that derivatives such as options are being used to cover bets on high-yield (risky...) instruments while highly-rated sovereign and corporate bonds are being bought with real money. This gives the appearance that there is strength in riskier assets but, in fact, it is just vapor.
The same may be said for equities, as the VIX has been allowed to float somewhat from its obviously repressed and manipulated levels of a few months ago. Derivates at a 50:1 margin are giving the appearance that the markets are going to move higher forever but that really is not the case.
The Australian dollar has reached obscene levels at over $1.09! This is simply incredible. Just incredible. That alone should tell you that something is really, really wrong in these markets and will not stand.
I have a feeling that sell in May and go away has never been truer.
Maybe this is the time to propose to an australian woman...she has reached her peak level of obscene exposure...it can only get better from now on! She will be sweet as sugar by winter. I think I'll short her right now! As you say, merry month of may is the best time to sell yourself down the river. Hope she can hear that, my euros are soo powerful right now!
None of this matters. The market is rigged and going higher. Fed has no choice. If you just assumed that this is a phoney market in 2009 would you have made money? NO one is going to try and stop the dollar sinking...they are making money in the stock market. No one is going to try and stop QE2,3,4,5.... they are making money in the stock market. No one is going to try and stop inflation...they are making money in the stock market. The rest of the world be dammed. I'm making money!!! Every congress person, every bureaucrat, every lobbyist, everyone who could say or do something is looking out for #1. As long as the Fed is driving up the market to try to somehow stimulate the wealth effect they are going to ride the train and who gives a rip about all the poor who don't own stocks and inflation is killing them. Where is there wonderful liberal compassion now?
Seems the big money is starting to get really, really nervous. They're just doing it on the down-low. I should say, trying to, anyway.
With insights like these, their machinations will only become more obvious until everyone and their brother knows about it. Of course, by then, it will be too late and becoming a bag-holder will be raised to a fine art.
Thanks for the piece.
:D
this is the best written "bearish" or "curb your enthusiasm" piece i've read on ZH--and as much as i appreciate the "hystericalism" here (much of it from me of course) a well needed piece. Clearly having one up AGAIN on the bear set ("growth will be slowing" before it would be stated here) that's but being opportunistic vis a vis the competition. "doesn't make it true" as they say. the irony that i have now found myself supporting the Bernank is not lost on me. He could be the Chairsatan after-all.
paradigm change and charts go out of the window....whichever way big money turns...its in such deep shit it has to leverage to make it worth the effort. That's the killer...leveraged play repeated at market level...means death to any trend even towards safer, lower beta, havens. As it's feeding the same credit beast that got us here in the first place. No where to run, nowhere to hide...except in leveraged plays...that's the killer!
The Oligarchs won't/can't deflate the credit beast!