Capital Context Update: Slow News, Mo Selling

From Capital Context

S&P futures diverged significantly from our risk basket as real selling pressure was evident in equity and credit markets.

On a day that seemed to bounce from one comical European leader's statement to another amid lower than average volume and little headline-making news except Tiny Tony's shenanigans, equities underperformed relative to credit markets and even more so relative to our risk basket.

Typically when we see this kind of divergence, we would argue that this is real selling pressure (as opposed to algos or 'people' arbing across correlated asset classes) and the fact that we are still early on in the month (first monday of June and mutual fund money flow expectations) does provide some more confirmation of that.

Volume was not heavy, though greater than average, as the S&P futures broke through its initial support at 4/18?s swing low, finding support at the 150DMA intraday closing just off its lows. We have been quite actively positioning for relative weakness in stocks as most clients and readers will know and
we posted this morning summarizing a number of the factors we are looking at for insights
.

The weekend action in Greece discussions seemed to get little attention but just as we described again and again recently, we saw GGBs and PGBs bid as basis traders filled more holes and gathered CTDs (cheapest to deliver bonds) - even as CDS widened and financials across the pond were relatively stable. There is very little chance that whatever approach is selected from voluntary restructurings will not eventually trigger CDS (at relatively low recoveries) and so we are seeing basis compress increasingly in other European sovereigns - so beware talking heads telling you bond yields are dropping so all-is-well because it isn't! Corporate credit land (EU and US) was not so lucky as Europe caught up to late Friday's action and US extending its losses (widening in HY to its worst since 12/6/10 - so exactly six months!).

Financials and Energy sectors were hardest hit as QE2 unwinds gather pace.

Financials and Energy names were by far the hardest hit on the day (in equity and credit) and remained in a world of their own all day as it seems the inevitable unwind of the QE2 trade is impacting them (as we expected and commented on in previous weeks). Financials hold a special place in our heart as we have been aggressively pointing out the disconnects in their capital structure and
posted earlier today on the details of this interesting segment
. By way of example, our long-running low cost long vol trade with insurers saw them wider by around 3% today while IG was around 1.5% wider - this remains a trade we think that has significant legs.

Breadth was very weak once again in credit land and curves flattened in 3s5s across the majority single-name CDS even as 5Y decompressed. Both HY and IG remain extremely cheap compared to their underlying fair-value (consider if the S&P 500 were trading at 1300 but the aggregate of the 500 individual components implied a value of 1350) with IG for instance around 4% (4bps or so) wider than its fair-value (and HY 20-25bps or so cheap).

We have discussed this at length in the past as we see initial concerns trigger blanket protection bid in the most liquid entities (whether you are long CMBS, bonds, or even CDS). Typically this is arb'd away quite quickly but this has not been the case this time and combined with the weakness in secondary bonds and equities (and increasingly in single-name CDS), we are starting to see some concern among market participants that this is more than a dip to be bought.

In
secondary bond land
, there was net buying overall which makes some sense as up-in-capital-structure and up-in-quality continues but volumes were also low there too. There was significant evidence of duration reduction as 3-7Y and >12Y was sold mostly in favor of 0-3Y debt even as TSYs actually saw yields rising and steepening at the longer-end.

Vol land made sense today as VIX rose close-to-close (as did VXV) having followed the inverse route of the S&P all day as expected. Interestingly though, implied correlation fell in the morning as stocks bounced a little and index vol fell but it never recovered as vol increased all afternoon. The relative strength in index vol and drop in implied correlation signals that single-name protection was just as desired in the afternoon and indeed it was from within our context universe).

The most expensive sectors in equity land relative to credit (based on our conetxt models) are starting to revert more as QE2?s flush is onwound.

Contextually
, credit pretty much outperformed across the board in terms of quality cohorts today and at the sector aggregate only Consumer Noncyclicals saw credit underperforming equity even though both lost ground on average. Energy was by far the worst relative performer in equities against credit today but the theme of the day was evidently unwinding some of the relative froth we have seen and discussed at length from equities relative to credit.

Many of the
most expensive (relative to credit expectations) sectors
such as Energy, Healthcare, Transports, and Basic Materials were all relatively sold hard today against credit outperformance (even if they weren't on a standalone basis). It is somewhat reassuring to see the relative contexts of the sectors draw closer together as QE2 ebbs.

Interestingly low beta names saw underperformance in CDS today as high beta names managed a small compression on average. This has the smell of index arb beginning and also investors seeking low cost protection baskets (or FtD baskets perhaps) as affordable systemic hedges. High beta stocks lost notably more ground today than low beta stocks and the anomaly in vol that has been evident for a week or two (that of low beta vol being bid while high beta vol not so much) has equilibrated today. Remember we viewed that as managers hedging their higher quality names while selling down their lower quality momo bets - it seems the bet has helped and now we are seeing broader hedging as down days accelerate.

On a day with 62% of CDS wider, over 90% of the stocks we track in our context universe were lower in price and 99% higher in vol. It seems that finally we are seeing the growing convergence back to reality of the equity market (too high) and credit market (stable but widening). We have charted this again and again from various perspectives but find the most succinct way to consider this from an actionable perspective is our
TAA model and stock indicator guage
. This aggregates all of our top-down perspective into a single view that should help managers and individuals alike in allocation decisions and trade ideas.

Bottom line
: PIG bonds outperformed purely and simply because basis traders picked up them for assurance and nuisance value, sovereign risk remains at or near record levels, financials in Europe were stable for a change as US financials lost ground (we think this is a great signal that our earlier
discussed CDS technical
is unwinding), Index skews (how much the index trades away from fair-value) continues to be wide and worrisome and the longer it continues the uglier the final outcome might be on single-name CDS, QE unwinds in financials and energy stocks are also bringing them back into line with their credit and vol cousins, no let up in tension for homebuilders as they lost significant ground today in credit and stocks (HOV didnt help!), European non-financials notably outperformed US non-financials (in IG and HY) today - perhaps a sign of a reawakening that US growth won't be what it is expected to be.

Trades remain HY-IG decompression, short stock/long credit arb, short insurers/long IG arb, short financials stock, long XLF/long protection arb, HY 3s5s flattener, TAA is still flat/fully hedged equity, and covering sovereign basis trades if possible is preferred.

LATE UPDATE
:
the news that TIN and IP are getting together was much less ebulliently (as you'd expect) received by the credit market.
IP
is 13bps wider at last look (10% or around 5 standard deviations) while its stock is around 3% higher afterhours. As you would expect TIN CDS compressed handsomely from 150/155 to 105/115 - intriguingly inside IP's current 133/143 level. Happily we note that
TIN
is a member of
our A-List
and the 38% jump after-hours should help performance considerably!

Index/Intrinsics Changes

CDX16 IG
+1.81bps to 96 ($-0.06 to $100.15) (FV +1.15bps to 92.79) (84 wider - 25 tighter <> 60 steeper - 63 flatter) - Trend Wider.



CDX16 HVOL
+1.58bps to 152.58 (FV +1.79bps to 154.94) (21 wider - 5 tighter <> 14 steeper - 16 flatter) - Trend Wider.



CDX16 ExHVOL
+1.88bps to 78.13 (FV +0.95bps to 73.93) (64 wider - 32 tighter <> 49 steeper - 47 flatter).



CDX16 HY
(30% recovery) Px $-0.41 to $100.75 / +10bps to 481.5 (FV +6.66bps to 458.4) (85 wider - 13 tighter <> 39 steeper - 61 flatter) - Trend Wider.



LCDX16
(70% recovery) Px $-0.37 to $99.875 / +9.73bps to 279.09 - Trend Wider.



MCDX16
+2.43bps to 128.43bps. - Trend Wider.



ITRX15 Main
+0.25bps to 103.75bps (FV+0.17bps to 107.06bps).



ITRX15 HiVol
+0.75bps to 141.75bps (FV+1.1bps to 142.48bps).



ITRX15 Xover
+4.25bps to 389bps (FV+6.04bps to 377.25bps).



ITRX15 FINLs
0bps to 153.75bps (FV-1.07bps to 154.3bps).



DXY
strengthened 0.27% to 73.98.



Oil
fell $1.35 to $98.87.



Gold
rose $2.85 to $1544.8.



VIX
increased 0.54pts to 18.49%.



10Y US Treasury yields
rose 0.9bps to 3%.



S&P500 Futures
lost 0.82% to 1285.7.

Spreads were broadly wider in the US as all the indices deteriorated. IG trades 3.9bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.6s.d.. At 96bps, IG has closed tighter on 193 days in the last 624 trading days (JAN09). The last five days have seen IG diverging from its 50d moving average. HY trades 11.2bps wide (cheap) to its 50d moving average, which is a Z-Score of 3.7s.d. and at 481.46bps, HY has closed tighter on 142 days in the last 624 trading days (JAN09). Indices typically underperformed single-names with skews widening in general (once again!!).

Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY underperformed by around 5.3bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 5bps, and stocks underperformed IG by an equivalent 1.3bps - (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 International Paper Company (+16bps) [+0.13bps], Hartford Financial Services Group (+8bps) [+0.06bps], and RR Donnelley & Sons Company (+7bps) [+0.05bps], and the best performing names were ERP Operating LP (-2bps) [-0.02bps], Quest Diagnostics Incorporated (-2bps) [-0.02bps], and Kinder Morgan Energy Partners LP (-1.56bps) [-0.01bps] // (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 (+76.58bps) [+0.54bps], MGM Resorts International (+28.98bps) [+0.27bps], and iStar Financial Inc. (+23.29bps) [+0.22bps], and the best performing names were Temple-Inland Inc. (-44bps) [-0.5bps], Owens-Illinois Inc. (-7.28bps) [-0.08bps], and Dynegy Holdings Inc. (-6.87bps) [-0.05bps] // (absolute spread chg) [HY index impact].

Among the European IG names, the worst performing names (on a DV01-adjusted basis) were Portugal Telecom International Finance B.V. (+7.7bps) [+0.06bps], Nokia OYJ (+4.96bps) [+0.04bps], and Holcim Ltd (+4bps) [+0.03bps], and the best performing names were Credit Agricole SA (-6.36bps) [-0.05bps], Banco Santander, S.A. (-5.22bps) [-0.04bps], and Lloyds TSB Bank Plc (-4bps) [-0.03bps] // (absolute spread chg) [HY index impact].

Comments

[Yen Cross]

 I am literally looking at Scorpions.vHope I spell; Yuck.  I refuse to dip the stinger.

     They eat the stinger!

[rocker]

'Pig Bonds outperformed'   Stupid is as stupid does. Why them?  I recently took a small position in Emerging Market Debt for the yield.  At least most EMs have better balance sheets.