Closing Context Update: Protection Bid Across All Assets

From Capital Context

S&P futures closed close to session lows and notably weaker open to close.

After a solid open to the day session, thanks to the insta-pop headline-based algo triggers on a better-than-expected NFP print, the reality of participation rates and a continuing deleveraging in the commodities (and contagiously every other asset class) sector exaggerated a USD rally and derisking in general in stocks and credit. A late day rumor of crude margin hikes also didn't help things and while we closed off the lows/wides of the day in equity/debt, the drift all day was very weak.

Credit narrowly avoided five days in a row of decompression in IG and HY spreads by pulling back to unch to very modestly tighter by the close and we want to point out some of the relative shifts in stocks today as job jubilence (and market reaction) seems a little overdone (judging by the news channels). S&P futures closed unchanged (well ok +0.5pts) which is 11pts below the level it traded at the open of the day session. S&P cash closed +5pts but unch from its opening level while SPY (the ETF) managed an equivalent 6pt gain close to close (+$0.59) but was down an equivalent 7pts (-$0.7) from open to close.

We are using S&P futures as they are more liquid, accessible 24hrs, and are used by more professionals for hedging - so
credit narrowly outperformed equity today (a continuance of the theme and in line with where we see fair-value shifts) but both equity and credit were very weak from open to close today, and more importantly we saw significant protection (derisking) across most asset classes today.

IG appeared to very slightly edge HY today as far as outperformance and low beta credits handily outperformed high beta with breadth actually better than we would imagine given index banality at around five-to-one wideners to tighteners. Intrinsics (the fair-value of the index based on the underlying components) notably outperformed today which is in the wrong direction from an index arb perspective (IG/HY are cheap/wide to fair-value - especially HY which suggests demand for 'blanket' protection remains relatively high) but given the lower liquidity this afternoon, we wonder if it is as simple as dealers not reracking so much into the close as index activity picked up post Greek rumors.

Before we dive into the rest of the day's action, it is worth considering the posturing in Europe today. Europe was closed so sovereign bond and equity markets were unavailable but FX and credit markets were open for business and we saw the EUR tank and Greek spreads pop 75-100bps wider (depending on whether you trust the executable levels) to record wides around 1420bps offered. Plenty of acrinomy broke out over the Der Spiegel piece and its accuracy but the fact that there will be an emergency meeting this weekend stoked fears further.

The Cash-CDS basis curve for GGBs suggests restructing unlikely within two years.

Our opinion of this is that it is highly unlikely that Greece will voluntarily leave the Euro (despite some appealing upside perspective to that deal) as the combination of major domestic holders of their sovereign debt and the fact that they have available funding for at least a year (if things are just terrible) and more like 2 two years. Greek spreads were well off their wides by the close of US trading in CDS land at around 1335bps mid (around 35bps wider on the day) even though the EUR close at its lows of the week/session - just above 1.43.

The hit-job on the EUR as we heard it discussed as was timely and effective but from our angle the incentive for Greeks to leave the EUR anytime soon is low (unless they - meaning all retail and institutional holders are plenty hedged/covered) and this remains the carrot with which the ECB et al can keep them playing ball. What does worry us a little is the story today that naked sovereign bond shorts are banned and a further shift towards sovereign CDS bans. Of course we would say that - given our backgrounds - but the reality of the situation is that outside of basis traders (Cash-CDS arbitrageurs) there is very little active buying of mid-to-longer-term GGBs (especially now the ECB has stopped).

The basis (see the chart above) remains fat and provides plenty of upside for those willing to step in (and funding does not seem to be a big issue for the basis books) and while there are plenty of technical drivers, the relationship suggests that there is considerably less likelihood of a restructuring event within two years than many believe (the oddness at the front-end reflects the cheapest-to-deliver option in CDS and not a real disagreement over probabilities of an event.

There is plenty of speculation in here as to what is going on but it seems from after-hours comments that the Greeks are vehemently denying it (though didn't they all claim they didn't need a bailout?). Long the EUR is the obvious repercussion trade (even if Greece did exit) - lower aggregate debt and higher per capita GDP growth? but we shy away from calls on FX especially in this wild and waccy market. Its enough for us to remain underweight EU financials vs non-financials and look for more XOVer-Main decompression.

Back to today's action and main themes. The main thing we note is a few themes just keep going and that there seemed a bid to more macro protection or overlays in general.

In
credit
,
CDS indices underperformed intrinsics
significantly, HY underperformed IG (and our
HYG-LQD position
inched into the money from the open entry at $40.3), high beta underperformed low beta, duration was reduced in CDS, and long-dated cash was very definitely sold relative to mid-dated.

The Vol term structure has risen to the top of its 'normal' channel - crisis or reversion this time?

In
vol
, we saw skews steepen, VIX elevate (in line with the equity sell off intraday) but what was most evident was the flattening of the vol term structure. VIX/VXV (think 1 month/3month vol) rose from an open at 88% to as high as 95.5% before pulling back a little into the close. This is the
flattest front-end since 3/28
and shows a demand for short-term protection (and necessarily foregoing the carry costs) that we havent seen in a while.

It does seem that every time too many people pile into the sell short-dated vol to fund mid-dated vol trade (see chart around 80%) the fingers get caught under the steamroller. At the current levels though we are at another crossroads where we have tended to revert if the pending crisis does not evolve and given our views on Greece, we suspect this flattening is overdone - at least for a trade with very clear stops indicated.

Towards the end of the day, it was indeed VIX (and not VXV) that compressed as we
saw implied correlation drop very fast (after pushing higher for much of the day up to yesterday's highs)
. We use this measure as a way to judge systemic versus idiosyncratic protection demand - when it rises it tends to mean traders are buying blanket protection (fast markets when liquidity is focused in indices or simply when macro fears are inflamed) and when it drops, one can think that demand for individual protection is relatively more bid. There are many moving pieces here but the significance of the drop towards the end of the day in implied correlation relative to the actual drop in index vol (which was not so great) is that we definitely saw
demand shift to protecting individual positions and away from macro
.
This fits with our recent theme of high beta (well lower quality actually and these are not totally fungible) equity selling and lower beta (higher quality) protection demand (as opposed to outright selling).

TSYs recovered all the NFP print losses (ex 30Y) and then some as the curve steepened modestly on the day.

In
TSYs
, we managed to retrace all the losses of the NFP print and then some in all but the long bond. The curve steepened (though modestly) for the first time since 4/27 but 2s10s remains 29bps below the April 8th swing steeps and for all but a bp or two back at DEC10 flats. 2s10s30s is as lows as it has been since early DEC10 (with the 3/16 spike down the only other print down here) and given the recent withdrawal of day to day liquidity whether by GC-IOER carry, FX vol too high for JPY carry, or even more simply the pending end of flip-that-bond QE2, we wonder what impact this will have on the US equity market as it has been a solid carry trade in the past.

The clear preference for IG credit over HY credit today from TRACE data (in terms of relative size flows) and the positivity of TSYs suggests further protection being sought higher up in the capital structure both top-down and bottom-up - a theme we have been playing and liking for a while.

Index/Intrinsics Changes

CDX16 IG
-0.21bps to 90.29 ($0.01 to $100.36) (FV -0.67bps to 88.98) (26 wider - 92 tighter <> 54 steeper - 70 flatter) - No Trend.



CDX16 HVOL
-1.8bps to 151.2 (FV -1.36bps to 147.9) (4 wider - 25 tighter <> 11 steeper - 18 flatter) - Trend Wider.



CDX16 ExHVOL
+0.29bps to 71.06 (FV -0.46bps to 71.08) (22 wider - 74 tighter <> 53 steeper - 43 flatter).



CDX16 HY
(30% recovery) Px $0 to $102.69 / 0bps to 434.3 (FV -5.79bps to 411.91) (12 wider - 85 tighter <> 66 steeper - 33 flatter) - Trend Wider.



LCDX15
(70% recovery) Px $+0.06 to $101.375 / -1.34bps to 238.94 - Trend Wider.



MCDX15
-2.97bps to 118.275bps. - No Trend.



ITRX15 Main
-1.46bps to 95.79bps (FV+0.4bps to 99.57bps).



ITRX15 HiVol
-0.61bps to 133.64bps (FV+0.32bps to 133.2bps).



ITRX15 Xover
-5.15bps to 352.85bps (FV-4.07bps to 346.53bps).



ITRX15 FINLs
+0.24bps to 133.12bps (FV+1.83bps to 134.04bps).



DXY
strengthened 0.75% to 74.75.



Oil
fell $1.97 to $97.83.



Gold
rose $18.03 to $1492.33.



VIX
increased 0.2pts to 18.32%.



10Y US Treasury yields
rose 0.2bps to 3.15%.



S&P500 Futures
lost 0.01% to 1334.9.

Spreads were mixed in the US with IG tighter, HVOL improving, ExHVOL weaker, and HY selling off. IG trades 1.8bps tight (rich) to its 50d moving average, which is a Z-Score of -0.7s.d.. At 90.29bps, IG has closed tighter on only 51 days in the last 604 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 12.5bps wide (cheap) to its 50d moving average, which is a Z-Score of 0.2s.d. and at 434.26bps, HY has closed tighter on only 51 days in the last 604 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 0.9bps (or 9139%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 0.7bps, and stocks underperformed IG by an equivalent 0.4bps - (implying IG outperformed HY (on an equity-adjusted basis)).

Among the IG16 names in the US, the worst performing names (on a DV01-adjusted basis) were Hewlett-Packard Company (+1.82bps) [+0.01bps], Johnson Controls Inc (+1.25bps) [+0.01bps], and Kroger Co (+1.17bps) [+0.01bps], and the best performing names were MDC Holdings Inc (-4.5bps) [-0.03bps], Toll Brothers, Inc. (-4.38bps) [-0.03bps], and Ryder System Inc. (-3.82bps) [-0.03bps] // (absolute spread chg) [HY index impact].

Among the HY16 names in the US, the worst performing names (on a DV01-adjusted basis) were K Hovnanian Enterprises, Inc. (+5.15bps) [+0.04bps], Eastman Kodak Co. (+4.39bps) [+0.03bps], and Cooper Tire & Rubber Company (+2.79bps) [+0.03bps], and the best performing names were MBIA Insurance Corporation (-40.44bps) [-0.28bps], Amkor Technology Inc. (-27.15bps) [-0.27bps], and Realogy Corporation (-28.42bps) [-0.24bps] // (absolute spread chg) [HY index impact].

Comments

[Racer]

Europe closed for all Friday????