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Capital Context Update: Weak Breadth and Rotation
From Capital Context
The rolling two-month HY-IG beta has dropped near 3x which empirically has signalled turning points.
Stocks closed at the lows of the day, losing a critical support level in the last hour or so and while S&P futures were only down 0.6% and credit spreads mixed at the index level, breadth was very weak and net selling in secondary bond land was significant.
Today's closing context will be short-and-sweet (isn't that what DSK said? first and last DSK joke we promise!) as critically it was just more of the same under-the-surface derisking with the exact same themes playing out that should have positioned clients underweight already and should be concerning to others.
High beta underperformance continued relative to low beta but there is still the important nuance that the lower beta vols are rising more than high beta which we have been pointing out for a week or two as symbolic of selling those lower quality high performing momo names outright and 'protecting' the better quality consistent performing low beta names with options. Perhaps the clarifying point today was the relative underperformance of the NASDAQ over the DOW and S&P but this should come as no surprise to anyone who has been paying attention.
Bond markets were graced with a GOOG primary issuance as secondaries were rather notbaly net sold with up-in-quality very evident (more so than in recent days) and only longer-dated maturities (greater than 12Y) saw any net buying as all cohorts below that saw net selling - and obviously TSYs were the beneficiaries as they rallied.
IG credit outperformed HY credit (with the former modestly tighter on the day against widening and flattening in the latter) but the afternoon trend was wider non-stop as IG prettyt much made it back to unch from the opening levels. HY's range was small and trading was choppy but breadth was very weak in the underlying names suggesting our recent comments regarding rotation from macro overlays to idiosyncratic unwinding was occurring. This was clear in secondary bond land too.
The upper chart shows a useful indicator that we often refer to when HY and IG are seemingly divergent. We have suggested that HY-IG decompression is the right trade here - there are many reasons that we have laid out again and again but the combination of risk-averse rotation into IG credit from LDI, boomers, and just the comfort from reaching up for some yield out of TSYs along with (top-down) strong fundamentals (though we have argued this as a panacea as opposed to a trend) suggests IG will be more comfortable as we see equities sag.
Our low vol HYG-LQD decompression trade has moved quietly into the money.
HY dispersion has been rising dramatically and while yields have approached all-time lows (which seems to be a big deal to many headline making wannabes), it is the spread that is critical to comprehend as that is truly what is compensating you for the additional risk - there really is no free lunch as we espoused previously on CNBC's Strategy Session at length on bond funds. Of course we recognize the importance of the yield to spread relationship and have also discussed that before butr for the sake of today's idea, we are focused on spread relationships as they offer the critical comparisons to other risk premia that we focus on placing in context.
Our point is that typically when the rolling beta between the two drops into the 3x region, it marks a turning point - typically a decompressing turning point - hence our desire to enter HY-IG decompression trades. Professionals can contact us for suggested betas but individual and financial advisors should look to our HYG-LQD trade weighting scheme which has shifted slowly but surely into the money recently.
HY has also reached back up to its 50-day moving average (in spread terms) as for the second day in a row equities underperform both IG and HY (especially) by quite a bit. In spread terms equity/vol space has underperformed HY by 20bps since Thursday's close - the largest underperformance since 3/16 and while this is significant (and we note we took healthy profits on our ETF Arb trade already), there is still a significant way to go before equities drop and vol rises to bring HY and our model-implied HY back into sync - and we expect this to happen driven more by equity/vol than HY from here. HY also saw further flattenig in 3s5s maturities (a negative) as 3Y intrinsics broke back above 300bps.
VIX and implied correlation moved tick for tick today with some notable flattening in the VIX/VXV term structure that we had warned was likely as VIX had overshot once again. Single-name vols moved less (relatively-speaking) than index vol overall but the theme we discussed above was evident in high beta vol (adjusted for moneyness and beta) moved less than low beta as protection was actuively sought.
Contextually, 41% of CDS were wider today (from our context universe) while 66% of stocks were lower in prices and 94% of vols were higher. Low beta CDS compressed on average and outperformed high beta as high beta stocks almost doubled the downside of low beta stocks today. For a change, sectors were mixed, with five showing relative credit underperformance and six relative credit outperformance. This is notable as a sign of discrimination that we suggested will occur as we stall from this straight line rally.
Equity generally underperformed but sector averages showed more divergence than normal.
Healthcare, Basic Materials, and Transports saw credit underperform what we would have expected from their equity/vol performance and at the other end Tech, Energy, and Services saw equities underperform expectations based on credit moves today.
In general, credit outperformed equity at the quality cohorts but was more mixed in the lower quality end of the spectrum than in the crossover space. We suspect this highlights the up-in-capital-structure preference for active credit or cross-asset funds (shifting to credit) but a mixed demand as dispersion rises for HY funds who are mandated to play in the lower quality region.
Among the worst relative performing credits (compared to model expectations based on equity/vol moves) we saw FE, SO, POT, COF, DHI, and KBH. At the other end with credit outperforming expectations, we have WFT, TGT, STX, ORCL, PDE, and MRK. This end of the scale definitely dominated by low spread names that rallied modestly in absolute terms as safety sought a home.
Bottom line
for today was that it was more of the same. Derisking under the surfgace, top-down remaining viable thanks to positive technicals and unwinds of hedges into underlyings. The strength in TSYs despite worries over the debt ceiling would suggest derisking from credit/equity is outweighing a potential delayed payment of interest here or there but our sense is this is all at a fine tipping point and once again our credit signals anticipated and we are now seeing equity confirm.
Europe
Financials underperformed as the DSK/Greece fears put some anxiety back into the mix. Main managed a small compression while intrinsics lost ground (index arb?) but it is very notable that only 5Y Main weas tighter on the day as the rest of its curve and intrinsics were all wider - which points to some technical flow as a driver. An exact opposite effect in XOver suggests that was the technical as XOver index underperformed (I like the Main-XOver decompression idea and more was added today) as the rest of the XOver complex compressed modestly.
SovX improved a little as HiVol widened a little but all the moves were marginal at best. Perhaps most interestingly we saw modest compression in the FINLs-Ex-FINLs spread led by ex-FINLs as the austerity contonues to advance across the united states of Merkel. FIN SUBs lost ground today and while sovereign CDS compressed, itr was again seemingly driven by more basis unwinds as the basis shifted back towards its wides quite quickly. Finally someone stepped and started picking up some PORTUG basis which was alone in its compression today but it is still very wide.
CEEMEA was more mixed with non-oil related names wider and oil names tighter though eastern european players Ukraine and Bulgaria were the worst performers.
Asia
Another day, another compression in the Japan-AXJ trade and we remain in it to win it. at 13bps we would start lifting the position at around 10bps (from 30bps entry) and be out by 0-5bps. AXJ underperformed as its banks lost further ground. Asia Pacific SovX names were all wider (except Japan) with Vietnam worst +12bps followed by China (as we heard chatter of some arb trades being set on China CDS and a hard landing).
Australia had a tough session with banks underperforming also and we still like that trade although we are underwater on it currently.
Index/Intrinsics Changes
CDX16 IG
-0.13bps to 89.5 ($0.01 to $100.39) (FV +0.21bps to 89.07) (47 wider - 36 tighter <> 59 steeper - 61 flatter) - No Trend.
CDX16 HVOL
+0.9bps to 148.9 (FV +0.69bps to 148.85) (12 wider - 10 tighter <> 13 steeper - 17 flatter) - No Trend.
CDX16 ExHVOL
-0.46bps to 70.74 (FV +0.06bps to 70.89) (35 wider - 61 tighter <> 50 steeper - 46 flatter).
CDX16 HY
(30% recovery) Px $-0.19 to $102.69 / +4.5bps to 434.3 (FV +3.77bps to 421.15) (63 wider - 21 tighter <> 49 steeper - 48 flatter) - Trend Wider.
LCDX16
(70% recovery) Px $-0.09 to $101.375 / +2.29bps to 245.14 - Trend Wider.
MCDX16
+0.75bps to 125.5bps. - Trend Wider.
ITRX15 Main
+0.31bps to 96.75bps (FV+0.06bps to 99.77bps).
ITRX15 HiVol
-0.25bps to 133bps (FV-0.28bps to 132.46bps).
ITRX15 Xover
0bps to 354bps (FV-2.41bps to 343.66bps).
ITRX15 FINLs
0bps to 136bps (FV+1.02bps to 135.95bps).
DXY
weakened 0.3% to 75.53.
Oil
fell $2.56 to $97.09.
Gold
fell $3.17 to $1491.85.
VIX
increased 1.17pts to 17.94%.
10Y US Treasury yields
fell 2.4bps to 3.15%.
S&P500 Futures
lost 0.54% to 1326.8.
Spreads were mixed in the US with IG tighter, HVOL wider, ExHVOL better, and HY selling off. IG trades 2.6bps tight (rich) to its 50d moving average, which is a Z-Score of -1s.d.. At 89.5bps, IG has closed tighter on only 43 days in the last 610 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 10bps wide (cheap) to its 50d moving average, which is a Z-Score of 0s.d. and at 434.26bps, HY has closed tighter on only 56 days in the last 610 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 4.9bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 4.9bps, and stocks underperformed IG by an equivalent 0.1bps - (implying IG underperformed HY (on an equity-adjusted basis)).
Among the European IG names, the worst performing names (on a DV01-adjusted basis) were BP PLC (+5.25bps) [+0.04bps], Commerzbank AG (+4bps) [+0.03bps], and UniCredit SpA (+2.5bps) [+0.02bps], and the best performing names were EDP-Energias de Portugal, S.A. (-7bps) [-0.05bps], Portugal Telecom International Finance B.V. (-3.5bps) [-0.03bps], and Rentokil Initial Plc (-3bps) [-0.02bps] // (absolute spread chg) [HY index impact].
Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were SLM Corp (+8bps) [+0.06bps], RR Donnelley & Sons Company (+7.5bps) [+0.05bps], and MDC Holdings Inc (+5bps) [+0.04bps], and the best performing names were Xerox Corp. (-4.25bps) [-0.03bps], FirstEnergy Corp (-3.75bps) [-0.03bps], and Kroger Co (-3bps) [-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. (+68.19bps) [+0.48bps], PMI Group Inc/The (+45.01bps) [+0.35bps], and Energy Future Holdings Corp. (+27.75bps) [+0.19bps], and the best performing names were Boyd Gaming Corporation (-7.06bps) [-0.07bps], Level 3 Communications Inc. (-6.68bps) [-0.06bps], and DISH DBS Corporation (-5bps) [-0.05bps] // (absolute spread chg) [HY index impact].
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"the time for the credit events to happen has arrived." the comps for USA Inc. are sheet going forward--we've had our requisite new disasters in the forms of Fukushima, Libya, a Euorpean Union that is officially now "in crisis" with a plain old slowdown in the USA as the "preciptator." I find nothing unusual that a low to no growth/low to no interest rate environment would "yield" such an event which even a standard equity correction of 10% only exacerbates let alone something more forceful. simply put the reckless spending is coming due and in my view those that have been responsible will be rewarded while those that are the opposite are going to be "taken to the woodshed" as they say. i still believe such a set events as they are occurring in Europe, appear to be occuring in Japan and are going to occur in the USA are healthy things as well--bailout nation (or was it "bailout world?") has run its course it's time to see whose been moving forward since 2008 to "use the government kindness" to fix their balance sheets and power their businesses back to independent health and those who have been simply planning another "bleed the taxpayer dry" business. i'm still waiting for an alternative to equities--even now amazingly--as every interest rate disaster call i've made though right at first keeps being proven wrong somehow. (I'm labeling this particular variant in honor of Mel Brook's The Producers--those who know know what i mean so i won't repeat it here.) i am now OFFICIALLY accusing the Federal Government of "Illegal Debt Levitation"--(think of that Buddist thing where the guru's hat thingy somehow floats above his head while he's "thinking really hard") unfortunately i can find nothing in the legal code that says such a thing even exists let alone that it is illegal. perhaps the end of the summer there will be something in the muni space.
After-hours update - IG and HY continue to drift wider (as ES drops) and IG has now pushed wider close to close (offered late at 90.375bps). The move wider was a little gappy but so was the open of ES after-hours but just as traders will let deltas run in a bull move, we saw two decent 0.5bps pops in IG as we crossed the open of today. HY was bid at $102.5 at its lows afterhours - and closed at its widest (435bps) since 4/21 (while IG is only at one week wides but in that crazy tight range it has held for the last three weeks).
intraday macro correlations over the last 4 or 5 sessions feel like we're working toward a coordinated puke of risk. technically, based on daily charts, it seems like that could occur tomorrow. as always, thanks for the credit update.