Capital Context Update: Short and Sweet
From Capital Context
Gold has been considerably more stable in the last few days as silver and now oil gap down.
Stock and credit markets closed weaker today as Europe came back to the party from their long weekend. Equities underperformed credit (beta-adjusted) and HY underperformed IG and while we didn't see the same picture in secondary bond trading as we have recently (up-in-quality and rotation from financials), it was evident that broader sentiment was negative and breadth was considerably weak in credit.
Oil joined Silver in its 'crash-worthiness' today as we see in the upper chart, but Gold remains slow and steady. We do not put ourselves out there as experts in precious metals and given where prices are, it is tough for anyone to justify anything fundamentally except for the devaluation hedge but we feel the need to comment - oil has desynced from gold and resynced almost tick for tick with silver ever since silver managed to get back up to unch yesterday.
Fundamentals of the silver trade do not seem to have changed but for the good of our blood pressure, we are remaining long gold (for its uncertainty hedge factor) and avoiding silver (not short silver note!). Along these lines we did wonder what kind of account can handle this kind of downswing without considerable liquidation needs and we would suggest that one of the reasons that gold has not 'crashed' akin to silver and oil is its holdings within central banks (no need for MtM pain on physicals there or collateral posting for synthetic positions).
The margin hikes and the sheer velocity of some of the moves in both oil and silver the last few days must surely have broken a few accounts and we saw some odd trading behavior after-hours in Gold (much more choppy than is normal) which we wondered whether was more margin accounts being forced to liquidate.
Of course this is the jinx but it appears to us that while gold has remained solid as the safe-haven anti-fiat trade (which we agree fundamentally applies - thouigh modestly less so - to Silver and Oil), other USD-denominated hard assets are struggling from speculative fever (are ahead of themselves but fundamentally in the right direction from a preserve capital perspective in a devaluation regime).
The reason we are nervous of the more speculative shifts we have seen in many of these USD-denominated assets is manifold. We have discussed all of the peripheral shifts we are seeing, whether in equity rotation, equity vols (hi vs lo beta), vol skews, credit up-in-quality rotation, cash underperforming,
(more safety bid - weill worth a read as there was some serious action here yesterday), credit term structure flattening, and now TSY outperformance (10Y TSY traded back below Bunds today for the first time since Jun09).
Critically, while hard assets do make some sense in a devaluation regime, the same is tough to say for US equities given the highly reflexive relationship between global demand aggregates and USD devaluation. Our expertise is in the relationships between debt and equity markets and the changing cycles of credit, business, and market. Along those lines, the chart opposite shows one of our longer-term cycle charts indicating stocks at a very elevated level relative to HY OAS, volatility, and vol skews (based on our non-linear cyclical capital structure framework).
The S&P500 is its most expensive relative to the rest of its capital structure since the OCT07 peaks.
We have outlined in recent weeks how our trading models are catching up in
but not in
and the underperformance of HY and while we often see people discuss how low yields are in HY and how the HY ETFs show little sign of weakness, we remind readers (aggressively) that these are all yield measures and judging relative risk from HY is all about credit risk compensation (and liquidity) as opposed to IG (which is more spread volatility and modest risk premium over time).
The point of all this is that our longer-term model indicates the S&P 500 is its most expensive relative to the rest of its 'capital structure' since the peaks in Oct07
. We strongly suggest that our up-in-quality theme be adhered to and if investors dabbble into the US equity market, we would prefer a modest underweight in any balanced portfolio. This is not armageddon calling but we also note some other interesting occurrences (both above and described below) that indicate to us that all is not well under the surface.
Skews have dropped quite notably in SPY in the last two weeks - we think providing room for small declines to be extended once again.
We casually discussed the highly complex topic of
delta and gamma hedging
impacts last week and received 100s of emails on the topic with regard to the velocity and gappiness of moves. Luckily most people we spoke with agreed with our perspective and the charrt below shows an interesting shift in SPY skews that has been occurring for a few weeks. The skew has been dropping - in two weeks the ratio of put vol to call vol (simplified explanation of the skew) has dropped quite significantly. This might seem 'bullish' - and in fact is somewhat - as the 'demand' for OTM put protection has seemingly dropped relative to calls but we see this as a potential indicator of room to fall.
The key thought being that all-the-while investors have major downside protection they will not be panicced into dumping their holdings into a sell-off - this is why we have not seen extended declines when small declines occur (well one of the reasons at least - ignoring Johnny 5 and his VWAP reversion algos for one moment). With
the skew dropping
, it seems investors are getting more 'confident' and in our humble opinion this
allows any downside shift now to be extended by weaker hands covering and selling into weakness
Yes, its a stretch, but the
climactic shifts in credit last week
seemed to exemplify the kind of gamma hedging exaggeration we get (and have seen before) and this
shift in equity skews could help explain the ability for stocks to rally in the face of declining macro fundamentals
(remember we showed the Citi Economic Surprise Index last week has diverged massively recently from US equities). We suspect we will see some interest in rebuying the skew given the -2 std deviations we now stand at but a sustained drop in the skew from here will havve our heckles up should we see a serious down day in US equities (think Friday's NFP number?).
Away from all this doomsaying, moves in credit land
were rather modest today - though mostly biased to the widening (or riskier side). IG and HY were wider with HY relatively underperforming. If we consider the US as a large capital structure, it was another clear shift up in the capital structure today as equities underperformed HY which underperformed LCDX which underperformed IG.
Financials underperformed non-financials
in the US and breadth was a dreary 5-to-1 in favor of wideners as term structures were generally mixed, slightly in favor of steepeners. Even though today's shift in HY was small, close-to-close it was the largest widening in almost two weeks inching HY back closer to its 50DMA. HY 5Y remains notably cheap (wide) of fair-value while HY 3Y remains rich (tight) suggesting indices being technically driven for the flattening trade which we like - perhaps it is time to extend that thesis into name-by-name analysis (we will dust off our curve screen soon to qualify this).
Contextually, equity and credit were relatively well balanced
with a slight bias to credit underperformance on a beta-adjusted basis averaged at the sector level. Low beta names underperformed in CDS (plenty of financials in here to drag that down) but we note that high beta equities handily underperformed low beta today. The latter point will tend to support why we saw Financials, Capital Goods, and Utilities all outperforming in equity relative to credit and Energy the worst hit relative to credit's outperformance on the day (along with Tech).
Credit tended to outperform equity (beta-adjusted) in the lower IG quality names
(A to BBB-) and was a major underperformer in the lowest quality names and less so but still weak in the best quality. A modest reach for yield perhaps? We think yes but dispersion continues to rise and even so in IG as discrimination continus to gather pace. Names that stood out as considerable equity outperformers relative to credit-driven expectations were FE, LZ, AVP, T, and IBM (a mix of low leverage releveragers and releveraging targets) while at the other end of the scale we saw CSC, FST, CYH, CLX, and COP as major credit outperformers relative to equity-driven expectations. Consumer Non-Cyclicals were the best performers today in credit while Tech was the worst and low beta vols continue to rise more day to day relative to high beta.
All-in-all, a relatively quiet day of orderly weakness in risk assets
- no panic except in oil and silver (which surprises us given the interconnectedness) but we are waving the
orange caution flag
here. Unless we see notably compression in HY spreads, we believe equities are due for a correction and skews/protection shifts are starting to allow that to happen. Our
continues to outperform and we remain fully hedged - which helps its somewhat option-like behavior or protected downside but solid upside. Our
is nicely in the money, surviving today's volatility at around $17.5 (from our short entry yesterday at $18.5-$19 at yesterday's open) - stay with the trade as we discussed above equity is overdone relative to credit here.
With traders back from a royal binge-fest, European markets were actually not as chaotic after yesterday's US action as we suspected. Sovs were mostly wider but nothing crashtastic - though we do note Spain underperforming considerably (unemployment data).
10Y TSY yields dropped below Bunds to the lowest differential in almost two years.
Sovereign bonds in the PIIGS nations tended to outperform, dragging the basis (the differential to CDS) notably narrower which may explain the move in Spain's CDS as its CDS are now wider relative to Germany than its bonds). On that note, it is perhaps worth pointing out that for the first time since Jun09, Bunds close higher in yield than US Treasuries.
Whether this is a reflection on US-EU growth, a renewed view of Europe as safe-haven, a currency play, a deflation perspective on the US, or simply a momentum chase is hard to say but one thing is for sure, this is a change from the channel of the last year or two and leaves a lot to the downside.
Remember we mentioned a suspicion that banks would step in to buy TSYs post QE2 ending to generate some NIM and carry (flatteners) without the GC-IOER trade and FX vol too high for carry there - perhaps this is some front-running on that flattener idea?
XOver outperformed Main today but this driven by the underperformance of FINLs to Ex-FINLs. More specifically, Main Ex-FINs rallied around 1bps, while FINs widened 2.5bps - this differential is sill notably below the empirically satsfying level given the width of SovX but we suspect this more reflective of the realization of more discrimination across Europe and less fear of contagion (good luck with that).
Notable underperformance for Asian and Australian credit overnight with the largest decompression in a few weeks. ITRX AUS widened 3.5bps with banks underperforming but it was Asian banks in general that showed weakness (Bank of China wider by 5.5% for example) as AXJ widened almst 3bps.
This decompression helped our Japan vs Asia-Ex-Japan trade as it compressed to 15bps (as Japan was unch/outperforming). We think this trade is worth sticking with for now though we want to keep an eye on Japan itself which widened 3bps overnight.
+0.5bps to 89 ($-0.02 to $100.41) (FV +0.78bps to 87.86) (97 wider - 20 tighter <> 55 steeper - 67 flatter) - No Trend.
+1.2bps to 148.2 (FV +0.92bps to 144.45) (21 wider - 8 tighter <> 13 steeper - 17 flatter) - Trend Tighter.
+0.28bps to 70.31 (FV +0.72bps to 70.67) (76 wider - 20 tighter <> 54 steeper - 42 flatter).
(30% recovery) Px $-0.19 to $103.06 / +4.5bps to 425.3 (FV +5.39bps to 412.04) (84 wider - 13 tighter <> 39 steeper - 61 flatter) - Trend Tighter.
(70% recovery) Px $-0.11 to $101.375 / +2.86bps to 233.89 - Trend Wider.
+9.55bps to 124.55bps. - Trend Tighter.
-0.25bps to 96.25bps (FV+0.15bps to 98.46bps).
-0.1bps to 135bps (FV+0.13bps to 131.97bps).
0bps to 352bps (FV+1.5bps to 343.35bps).
+2.41bps to 130.91bps (FV+0.4bps to 130.78bps).
strengthened 0.25% to 73.14.
fell $2.49 to $111.03.
fell $9.47 to $1535.88.
increased 0.71pts to 16.99%.
10Y US Treasury yields
fell 2.8bps to 3.25%.
lost 0.41% to 1352.2.
Spreads were broadly wider in the US as all the indices deteriorated. IG trades 3.1bps tight (rich) to its 50d moving average, which is a Z-Score of -1.2s.d.. At 89bps, IG has closed tighter on only 32 days in the last 601 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 14.8bps wide (cheap) to its 50d moving average, which is a Z-Score of -0.3s.d. and at 425.29bps, HY has closed tighter on only 31 days in the last 601 trading days (JAN09). Indices generally outperformed intrinsics 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 2.1bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 2.1bps, and stocks underperformed IG by an equivalent 0.9bps - (implying IG outperformed HY (on an equity-adjusted basis)).
Of the European IG names, the worst performing names (on a DV01-adjusted basis) were Banca Monte dei Paschi di Siena SpA (+3.76bps) [+0.03bps], Edison SPA (+2.96bps) [+0.02bps], and Lanxess AG (+2.24bps) [+0.02bps], and the best performing names were Portugal Telecom International Finance B.V. (-4.82bps) [-0.04bps], Volvo AB (-3.73bps) [-0.03bps], and ArcelorMittal (-3.85bps) [-0.03bps] // (absolute spread chg) [HY index impact].
Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were Whirlpool Corp. (+4.75bps) [+0.04bps], Expedia, Inc. (+4.36bps) [+0.03bps], and SLM Corp (+4.2bps) [+0.03bps], and the best performing names were Alcoa Inc. (-7.87bps) [-0.06bps], FirstEnergy Corp (-3bps) [-0.02bps], and Campbell Soup Company (-2.2bps) [-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. (+45.97bps) [+0.36bps], MBIA Insurance Corporation (+39.01bps) [+0.27bps], and Supervalu Inc. (+20.22bps) [+0.19bps], and the best performing names were Community Health Systems Inc (-24.62bps) [-0.24bps], Boyd Gaming Corporation (-14.82bps) [-0.14bps], and Unisys Corporation (-5bps) [-0.05bps] // (absolute spread chg) [HY index impact].