Closing Context Update: Low Beta Winning

From Capital Context

S&P futures diverged significantly from every other risk asset class in the last hour or so of the day (OPEX?)

Credit was a little more active than yesterday even as stock volumes neared the lowest of the year. Equities managed to outperform credit top-down very marginally but once again risk-appetite seemed marginal at best - despite what seemed like an S&P futures ramp towards the end of the day in a world of its own.

Our risk-asset-based basket tracker for S&P futures shows a huge divergence at the end of the day that we have quite frankly not often seen. Whether this was OPEX-related, we are not sure, but it was certainly out of character with the entire rest of the world's asset classes.

Credit, both HY and IG, closed near the wides of their day, TSY yields closed near the lows of the day, and commodities were unable to really catch a bid as the S&P reached up towards the day's highs into the close.

Secondary bonds followed the path of least resistance of recent days/weeks and saw net selling in HY and net buying in IG (as primary issuance was healthy once again). Low beta names outperformed in both stocks and credit today and while we said top-down equity outperformed credit (and explained the equity index's seeming lonesome ebulience), it was not the picture bottom up as credit clearly outperformed equity at the sector aggregate level in all but Transportation names whose credit spreads did not enjoy the strength stocks seemed to attribute them.

Bottom-up showed a different picture with credit clearly outperforming equity once again.

Secondary bonds and CDS also told a clearer tale of today's tape as we saw crossover names notably the most (net) sold in bond land - as clearly cherry-picking and some capital structure arb was active in the very weakest of names (given our contextual models) and up-in-quality safe haven status in the best quality names. The crossover names also saw the largest rise in vols (relatively speaking) as better quality names saw some increase in vol (we are using 3M vol here to avoid OPEX-related shenanigans) but notably less.

Interestingly, Consumer Cyclicals, Consumer NonCyclicals, Utilities, and Services all traded pretty much in context between debt and equity today with Transports (as we said) the clear loser in credit relative to equity (though most did compress a little in spreads). Basic Materials and Healthcare saw the best credit relative performance to equity expectations today as both saw spread compression and stock prices drop (clear divergence there).

Costs for protecting USA rose 8bps or ~19% in the last two days (and TSY yields also rose 7-10bps).

Europe was weak in general with both financials and non-financials wider on the day, some more basis compression in sovereigns, but moves were in general quite muted. What isnt muted however is the
dramatic jump in the USA protection costs
in the last 2 days! USA CDS now trading 46/52 ish has jumped 19% (from 41bps mid to 48.8bps mid) in the last two days. Two things spring to mind: 1) TSY yields have also risen 7-10bps in thelast two days, and 2) Given the EUR-denomination of the USA protection, is this is a cheap way to play a EUR short? Either way, USA costs are now well above Germany's once again but not in nosebleed territory.

These contracts are not hugely liquid but we do see a large number of actionable runs during the day at least quoting them (today we drifted from 44/49 open to 47/52 near the close). Whether this is some fears over the debt ceiling re-appearing we are unsure (and quite frankly also unclear whether a delay of interest payment will trigger CDS - sorry for the unequivocal 'don't know' on this) but it certainly pushes USA costs up near recent highs. Along the thought process of the CDS trigger - the CTD would be interesting to consider and maybe this is a very smart way of playing for some upside in the event of a delayed payment (since there are some modestly lower priced Treasuries (super low coupon 1.25% of Oct15) that seem deliverable (but we really dont want to go that down rabbit hole).

Apologies for brevity but more of the same and arguably crazy town in stock indices into the close leaves us more nervous (well actually more comfortable having rotated out of stocks late April). Low beta preference and up-in-capital-structure seems set in its way and all the time we see concessions solid in primary issuance, basis traders and flippers will be satisfied. HY-IG remains in play and has legs from a systemic position. Our ETF Arb is getting close to a signal short but not quite but the HYG-LQD position is performing in our favor. Sector wrap should be ready for tomorrow (with over 90% of S&P haviung reported) and we promise some interesting perspectives on the fundamentals and trading biases.

NOTE: there are no CDS or options on LNKD and so we have no comment but felt the ubiquitous need to have that ticker in our stiry was critical!! FYI - lack of borrow today and the fact that it was unable to break back above VWAP late in the afternoon does not suggest strong algo support - just saying.

Index/Intrinsics Changes

CDX16 IG
0bps to 88.75 ($0 to $100.42) (FV -0.79bps to 88.01) (19 wider - 86 tighter <> 58 steeper - 66 flatter) - No Trend.



CDX16 HVOL
-2.6bps to 146.9 (FV -1.69bps to 147.06) (2 wider - 26 tighter <> 17 steeper - 13 flatter) - No Trend.



CDX16 ExHVOL
+0.82bps to 70.39 (FV -0.52bps to 70.04) (17 wider - 79 tighter <> 54 steeper - 42 flatter).



CDX16 HY
(30% recovery) Px $+0.13 to $102.63 / -3.1bps to 435.7 (FV -2.3bps to 426.88) (21 wider - 62 tighter <> 56 steeper - 40 flatter) - Trend Wider.



LCDX16
(70% recovery) Px $+0.08 to $101.375 / -2bps to 246.67 - No Trend.



MCDX16
-2.14bps to 119.615bps. - Trend Tighter.



ITRX15 Main
+0.25bps to 98bps (FV+0.19bps to 101.01bps).



ITRX15 HiVol
-0.25bps to 133bps (FV+0.71bps to 134.61bps).



ITRX15 Xover
+1bps to 358bps (FV-2.04bps to 347.56bps).



ITRX15 FINLs
0bps to 140.25bps (FV+0.36bps to 139.04bps).



DXY
weakened 0.5% to 75.1.



Oil
fell $1.42 to $98.68.



Gold
fell $2.1 to $1495.05.



VIX
fell 0.71pts to 15.52%.



10Y US Treasury yields
fell 0.9bps to 3.17%.



S&P500 Futures
gained 0.2% to 1341.3.

Spreads were mixed in the US with IG worse, HVOL improving, ExHVOL weaker, and HY rallying. IG trades 3.4bps tight (rich) to its 50d moving average, which is a Z-Score of -1.4s.d.. At 88.75bps, IG has closed tighter on only 33 days in the last 613 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 8.7bps wide (cheap) to its 50d moving average, which is a Z-Score of 0s.d. and at 435.69bps, HY has closed tighter on 63 days in the last 613 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 outperformed by around 3.1bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 1.2bps, and stocks outperformed IG by an equivalent 0.9bps - (implying IG underperformed HY (on an equity-adjusted basis)).

Comments

[skepticCarl]

please....PLEASE......PLEASE define your acronyms at least once, preferably when they first appear.  That should be very simple to do.

What is not simple, is to write so that the majority of us understand your point.  I have re-read your articles several times over the past few days, trying to discern what "spreads" you are talking about, and the ramifications of the "divergences". I am still clueless, after making a genuine effort to read your article carefully and fully.

[CapitalContext]

Thank you SkepticCarl for the feedback. It is a tough balance between defining every acronym and cross market oriented comment we make and any coherence but we will be more diligent in future.

When you mention which 'spreads' we are talking about - it is credit spreads and typically I will define whether I am talking about HY (high yield) or IG (investment grade) and whether I am commenting on bonds or CDS (credit default swaps). Divergences are straightforward in my view in that they are really just moves away from what I would have expected - for instance in today's last hour or so S&P futures rallied pretty well while the typically highly correlated risk assets or carry-drivers (e.g. AUDJPY, gold, oil, 2s10s30s, etc) stayed down (as did credit spreads which we would have expected to rally (rally meaning tighten or as we say compress) - hence we say S&P futures diverged from risk assets and in our view that divergence is unsustainable - and given the lack of follow thru in other assets we would suggest short S&P futures but the cleaner trade is an arb (though we hope if you have your own trading bias that this observation will help confirm or deny your idea). Sometimes the best trade is the one you didn't make.

In the credit-equity context when we discuss sectors for instance - we would typically expect a sector with good equity performance on a day to have good credit performance (tighter spreads) and we use frameworks to understand how much an equity or volatility change will impact spreads and vice-versa (that's what we mean when we use the term beta-adjusted - its not really beta as our framework is non-linear but it means - what we'd expect credit to do if equity moved as it did). Sometimes we see wider spreads and rising stock prices or tighter spreads and rising volatility - relationships that are out-of-sync - there are many reasons for this and we try to point them out - typically it is capital structure change-related but sometimes it is simply flow.

As far as ramifications are concerned, typically we will outline where we feel there is an edge to the divergence - our recent ETF Arbs have been great examples of that. Currrently we feel there is an edge in HY-IG (and have previously suggested ETF trades to take advantage of that for non-professional investors without access to CDS markets for instance). We have been quite clear that there is a preference for credit ovver equity and has been for a while, a preference for IG over HY (or up-in-quality rotation) and have suggested being more and more underweight equities for a few weeks now. One thing our institutional clients have taught us over the years is the need for actionable ideas and we will continue to try.

I hope this helped and please do not hesitate to contact us directly or simply comment on ZH if there are specifics you are unsure of. A lot of what we write about is relatively complex and we will continue to try to better explain what we glean from the credit-equity-vol context to provide actionable ideas. As an FYI - maybe kick around the site www.capitalcontext.com - there is a lot there that is very specifically actionable (and its free) for many types of investor (start with the Getting Started section).

Thanks again for the frankness.

[FOC 1183]

Sometimes the best trade is the one you didn't make

FTMFW

[ceilidh_trail]

   I agree with skepticcarl...

[rocker]

The main point is that the S&P gained as others did not, IE commodities and such from what I get.    

[FOC 1183]

"a huge divergence at the end of the day that we have quite frankly not often seen"

What is even more bizarre is that the divergence took place on a day when correlations were in the 90's (i.e., a statistically significant divergence [1.5-2.0 sigma] wouldn't be that surprising if the intraday tracking had been low [r = 60ish?].  OPEX is the only legitimate explanation (aside from Citadel routed FRBNY market orders :) ).

As for the ZCTOs, yesterday I saw a few hardline comments from Republicans which could have explained the widening.  Today was more of a head scratcher, as I saw nothing meaningful to account for it.  Maybe just liquidity??  Guess we'll no in a few trading days.  Thanks for the update

[CapitalContext]

Thanks for comment. Yes liquidity could have plenty to do with it I agree. Didn't have a chance to stick this chart in the post but shows the differential between Germany and USA at an interesting 'inflection' level. Interesting thought experiment though as to what happens if USA triggers CDS - CTDs are very close to Par (cf. FNM/FRE) and EUR-denominated premium stream would cease. Bet is really that the small USD gain on CTD (recovery) would offset EUR payments to trigger date - especially if you assume that debt-ceiling issue-then-resolution would be dollar-neutral (or maybe even positive) even if it triggered CDS and that PIIGS have enough issues that a USA 'issue' would stagger Europe perhaps - that argument can go round in circles very fast.

[FOC 1183]

What a tangled web we weave....