Commentary courtesy of www.creditresearch.com
Spreads closed wider today with HY underperforming IG and for the sixth day in a row, credit underperformed equity on a beta-adjusted basis. The IG and HY indices closed off their worst levels of the day (just prior to the Fed comments) but notably underperformed stocks in the subsequent rally as every correlated asset class disconnected from stocks post Fed.
This was a day of three parts to a great degree: pre-market, pre-Fed, and post-Fed; with credit underperforming equities through each phase and financials weak in general - particularly the majors. IG closed at its widest level since 7/28 and HY its widest close in August. IG and HY saw their largest close-to-close widenings since 7/16 (in percentage terms) - the day of the big drop in Consumer Sentiment.
In the overnight (pre-market) session there was plenty to worry the bulls but the downward slide in stock futures started before China's weaker than expected import growth and slowing housing data which served to kick it while it was down. The divergence between US stocks and both TSYs and AUDJPY was extremely evident (as JPY strengthened on the beginning sof carry trade unwinds overnight). A lack of action from Japan and some decent earnings spurred further JPY strength and stocks started to converge down fast.
As we slid through Europe, following UK's first downward move in home prices in almost two years, the risk-off trade contonued but we note that TSYs were slightly higher in yield - converging from the break late on Friday as the chances of QE2 annoucnements were eased back a little. Then as if to prove that it never rains, US nonfarm productvity unexpectedly (to some) fell much more than consensus, the NFIB small business optimism index dropped further and ICSC retail sales fell further than expected.
All of that saw sovereigns and financials in Europe contonued to weaken (as we pointed out yesterday) and lead to a notably weak open for US risk assets - S&P futures were -11pts at the US open, IG+3bps and HY +15bps. Notably Main and XOVer were around the same shift (+2.5bps and +13bps) which is outperforming given the compression in US credit yesterday but volumes in Europe were very low (as they were over here yesterday also). FINLs were definitely among the laggards out of the gate.
PIIGS were 8bps wider on average at 323bps with Ireland once again the weakest but the recent rise in USA risk seems to have got some coverage (widened from 36 to 44.5bps in the last few days) but we remind investors that this is priced in EUR and is not simply a default risk indicator - i.e. rates can remain low and CDS spreads high given expectations of currency devaluation on one hand and TSY manipulation on the other - of course one side of that equation will break in the end but these moves are not enough to be screaming about yet. Italy also widened notably as did its banks. China did widen overnight (as did the Chinese banks that we see runs for) on the back of chatter of Chinese banks being told to bring off balance-sheet loans onto their balance sheet perhaps impacting capital requirements. China trades at 82bps, its widest since 7/22.
One overnight news item that did catch our eye that perhaps is worth remembering is KKR pulling it secondary. Underwriters, we assume, just would not wear this one for them and external demand being lacking should surprise some (though not us given the lack of volume and outflows from equities) given recent equity strength - makes you question a few things actually - why would underwriters not take this one on given the upside from future 'deal volume' from the the big PE shop? perhaps they do not see a big PE comeback anytime soon? Anyway, these are all speculations.
As we started trading (pre-Fed) in the US day session spreads widened further and stocks slid to converge back to where TSYs said they should be from the mid-Friday break. The weakness in macro data unfortunatley continued once again with Wholesale Inventories dropping more than expected and IBD Economic Optimism dropping more than expected.
With TSY sideways to slightly lower in yield and stocks having converged back to their relative fair-value to TSYs, we saw a modest bounce in stocks (on no volume) as it hovered above Friday's lows. IG slid wider (on little volume also after an initial flurry) and traded wider than Friday's wides and made another wider wide just before the Fed statement - offered as wide as 106bps (while we note that stocks did not make a lower low at that time). HY was similar but tracked equity more closely in this period with it touching Friday's wides early on and dipping back down just pre-Fed statement but not making the wider wide that IG did.
The heavily oversubscribed (3.31 bid-to-cover) 3Y auction suggests notable demand for the safety and deflationary 'safe' haven of govt debt and the fact that it came almost 2bps rich to Bloomberg;s survey expectations is another indication that it is increasingly clear that return of capital is trumping return on capital (despite what Bob Doll would have us all believe). This took TSYs down a smidge in yield into the Fed statement and helped roll stocks down a little more as for about an hour there stocks and bonds stayed in sync.
Pre-Fed we saw levels as follows: IG +3.75bps, HY +17bps, 10Y 2.8109%, 2s10s 226bps, 30Y 3.977% AUDJPY 78, DXY 81.32, ESU0 1112.5 (-13pts) and some notable FINLs movers were JPM +9bps and GS +8bps with USA at 44.75bps. At that time IG intrinsics were +3.25bps and HY were +10bps so indices were underperforming intrinsics and underperforming stocks.
As the Fed statement released, there was an immediate divergence between stocks and TSYs and risk was both on and off at the same time (sarcasm sorry). TSY yields sub 10Y dropped dramatically as did the dollar but AUDJPY (and EURJPY) stuck relatively still as stocks took off on large volume (as the blind lead the deaf) on the mere mention of an easing. The more modest recovery comments and balance sheet stability that the Fed offered up seemed not enough to please though stocks did rally all the way back to unch at one point before given back half of those gains into the close.
Critically, though IG and HY did come off their worst levels, they certainly never saw the froth that stocks seemed to get and even more critically the movements in TSY curves must have left some investors mortally wounded (and perhaps explains why the two major carry pairs did NOT follow risk assets higher - i.e. pain trades being unwound into carry unwinds held them down even as the dollar gave up all its gains on the day). Gold jumped $10, back above $1200, as a somewhat modest indication of the weakening trust in the dollar perhaps.
Some items that stood out for us was the NoB (10s30s) broke to all-time record steep levels above 125bps (who wants to hold long-term US debt?). The spread between 2s10s and 10s30s dropped below 100bps once again with the ratio (perhaps more important given the low rates) back to 2007 levels. 2s10s dropped notably (trading under 221bps briefly) now clearly back to MAY09 levels - though it is 80bps off record steeps from last year, it is still at the steeper end of the historical spectrum and on a ratio basis (again trying to account for the extremely low rates and duration differentials) the 5.3x ratio of 10Y over 2Y is astronomical (especially given the 4.25x ratio of durations for the two bonds) - implying a 56bps carry earned for duration-neutral steepeners (which really does not seem enough to encourage anyone to take that risk given the Fed's approximate $20bn per month purchases in this segment of the curve). 7 and 10Y remain the most attractive on a Yield/Duration basis with 7Y having better roll-down.
The level of disconnect intraday post-Fed between 10Y and stocks was incredible. The 12pt rise in ES (S&P e-mini futures - the most liquid index product) was accompanied by a $0.4 move in HY and 1bps compression in IG as VIX fell by around 1pt. On a beta-adjusted basis, HY outperformed IG by around 5bps in that move but stocks outperformed HY by around 6-7bps - i.e. significantly. The fact that stocks almost reached yesterday's closing highs while IG remained 2.5bps wide of it (and 1bps wide of yesterday's wides) and HY over 6bps wide of yesterday wides at its best should indicate the relative 'craziness' in stocks during that period as they acted alone leaving all carry-driven strength aside.
By the close stocks remained well ahead of credit and we point out, as we have recently, that the gap top-down between HY and IG credit index values and the S&P/vol implied values continues to shrink - now for the sixth day in a row - i.e. credit is making a turn for the worse here - despite the demand side being as ebulient as ever in new issue IG land.
Both IG and HY were off their best levels of the day into the close, ending up just wide of where they opened the US day session (again compare to S&P's 5pt or so gain from open to close). Single-names remained weaker all day and in fact HY intrinsics underperformed as the index tracked stocks back post-Fed. Intrinsics closed at their wides of the day in both IG and HY.
Post-Fed: IG -1bps, HY-4.5bps, 10Y -5bps, 2s10s -2bps, 30Y +3bps, AUDJPY unch, DXY -0.5pts, ESU0 +9pts and CDS single-names underperformed - spot the odd one out?
FINLs opened notably wider with insurers weak but the majors notably more so on a relative basis, leaked a little tighter around the Fed statement only to leak back to unch from the open and 5-8% wider on the day with JPM and WFC underperforming notably (mortgage exposure?) relative to GS and MS (less direct lending exposure?). Quite honestly the JPM/WFC underperformance smacked of 'grab the cheapest carry cost FINL names as a short' rather than any specific allocation decision - and worked out well.
There was a lot of red in CDS land today with builders, autos, and energy names notably weaker. Breadth was very negative with early reracks seeing little interest in aggressive rerisking as wideners outpaced tighteners by around 15-to-1. Telecoms was the worst sector followed by Finance, Consumer Cyclicals, and Leisure while Healthcare saw the safety bid and while it widened on average was by far the best performer followed by Consumer Noncyclicals. Utilities did not escape the selling pressure today and really saw no strong bid as the independents put them under pressure.
Across ratings there was little themes evident although if we squinted we may be able to make out a modest outperformance by BB to B names relative to the best rated names. With credit weaker, we saw LBO names outperform (as some premium is lifted) and CDO-referenced names underperformed - as did IG9 - continuing the recent roll decompression.
As an aside, for the month of August, IG +0.375bps, HY -9bps, S&P +20pts, VIX -1.25pt. Credit underperforming by around 4bps IG and 10bps HY beta-adjusted versus S&P/Vol and furthermore - HY is the only major index to actually show compression on the month with ITRX Main, XOver, FINLs and SovX all wider. Breadth is surprisingly balanced in single-names with ENRG the big winners thanks to dramatic moves by RIG and APC - US FINLs are outperforming ExFINLs so far (but giving some back today) as EU FINLs are notably underperforming EU ExFINLs once again.
All-in-all it was a hurry up and wait kind of day with some interesting fall-out. The Fed downgraded its assessment of the recovery (as expected) and went halfway to full QE (as expected by some). We tend to agree that this seems like the anti-Goldilocks statement - not enough for the bulls to ride the QE bus to Dow 40,000 but just enough 'carry a big gun' top stall the bears from an all-out assault (as QE could be around the corner). The economic statement alone should certainly ruin more than a few economist's nights and we have already seen big sell-side shops lowering GDP expectations - next will come earnings revisions for H2 and beyond. It should be clear that the housing market will not benefit from this QE implicitly or explicitly - those that can did, those can can't, well can't - and as we argued yesterday, a full-blown QE (as opposed to this queasy effort) would tend to signal a complete lack of confidence in the economy, and perhaps perversely cause the whiplash in commodity prices that many expected and implicitly input cost drags and the vicious circle of lower earnings and valuations across risk assets.
Where to from here seems clear to us though managing the trade around it is always troublesome. Macro-economically there is trouble ahead (just look at Fed's comments and the slew of data today alone), technically flows have maintained corporate risk at relatively low levels (lower even than stocks would suggest in the last month or more). The slowing economy 'signal' may well be the catalyst for a reduction in retail flow into HY funds (or at least should do given the considerably higher leverage to that stress that is hiding there) and IG remains a more comfortable place to hide. IG14 with its relatively heavy insurer exposure will have a higher beta to HY in a downturn than a 'normal' IG exFINLs basket and while this is tricky to do we suggest getting long IG exFINLs (use today's MFCI for more detailed asset selection) at around 98bps against either a basket of insurers or the HY index itself.
While these are more top-down ideas (and we have others - just call for a chat), we remain bottom-up RV guys at heart and as Byron pointed out in today's MFCI, the increasingly correlated (and less disperse) asset values make for tough times. While a tighter dispersion might make for better RV opportunities as weakness/strength become discriminated, the high correlation or perhsps more specifically - the shift to a single-factor market model to some extent make those bets tough to stomach sometimes. However, we believe that is the way forward and so far so good whether in single-name CDS, our vol picks, or even our credit-justified equity long-short model, RV and arb trades have done well in this topsy turvy fundamentally bereft technically-driven market.
The signal from the credit market is clear and has proved right time and again at turning points (whether long or short-term) and that is a slowing of the risk-on rally of the last month or two. The consistency of the last six days underperformance (even as last week's flows maintained decent levels) should be at least pause for thought for tactical asset allocators. FINLs remain our bugaboo (not sure if that is a word used in the US) as the opacity of their balance sheets, reduction of 'easy money from a flattening term structure, FINREG issues, and less MBS help, combined with higher volatility trading regimes (hurting trading revenues), and most of all the need to roll billions of dollars of TLGP debt soon - make us consider them a much more attractive short in credit land (and increasingly so in equities too from our CSA model) as we watch the seemingly impregnable EUR financials leaking back fast, we suspect that fear will soon reach our shores once again.
CDR LQD 50 NAIG +3.07bps to 96.89 (45 wider - 2 tighter <> 28 steeper - 20 flatter).
CDR Counterparty Risk Index rose 4.23bps (3.5%) to 124.93bps (13 wider - 1 tighter).
CDR Government Risk Index rose 3.57bps (4.04%) to 91.75bps..
CDX14 IG +2.75bps to 104.75 ($-0.12 to $99.8) (FV +3.25bps to 107.33) (113 wider - 7 tighter <> 56 steeper - 66 flatter) - Trend Wider.
CDX14 HVOL +7.94bps to 152.94 (FV +5.33bps to 0) (29 wider - 0 tighter <> 7 steeper - 22 flatter) - Trend Wider.
CDX14 ExHVOL +1.11bps to 89.53 (FV +2.61bps to 89.34) (84 wider - 11 tighter <> 46 steeper - 49 flatter).
CDX14 HY (30% recovery) Px $-0.5 to $98.16 / +12.7bps to 546.2 (FV +10.07bps to 567.13) (93 wider - 5 tighter <> 23 steeper - 74 flatter) - Trend Wider.
LCDX14 (70% recovery) Px $-0.25 to $96.88 / +6.96bps to 333.07 - Trend Wider.
MCDX14 +6bps to 215bps. - Trend Wider.
ITRX13 Main +2.75bps to 105.5bps (FV+3.16bps to 108.66bps).
ITRX13 Xover +12bps to 481bps (FV+9.07bps to 474.36bps).
ITRX13 FINLs +5bps to 122.5bps (FV+4.72bps to 126.47bps).
DXY strengthened 0.21% to 80.88.
Oil fell $1.22 to $80.26.
Gold rose $2.45 to $1203.8.
VIX increased 0.23pts to 22.37%.
10Y US Treasury yields fell 6.9bps to 2.76%.
S&P500 Futures lost 0.56% to 1119.3.
The biggest absolute movers in IG were Anadarko Petroleum Corp. (+37.5bps), SLM Corp (+13.71bps), and GATX Corporation (+13.25bps) in the underperformers, and Loews Corporation (-1bps), AT&T Mobility LLC (-0.77bps), and Aetna Inc (-0.75bps) in the outperformers. The biggest percentage movers in IG were Anadarko Petroleum Corp. (+13.39%), XTO Energy Inc (+11.47%), and Sara Lee Corp. (+8.63%) in the underperformers, and AT&T Mobility LLC (-2.01%), Aetna Inc (-0.99%), and Loews Corporation (-0.87%) in the outperformers.
In Main, the biggest percentage movers were Solvay SA (+9.67%), Energie Baden-Wuerttemberg AG (+8%), and Sodexo (+7.65%) in the underperformers, and Imperial Tobacco Group Plc (-1.49%), GDF Suez (-1.32%), and Auchan SA (-0.87%) in the outperformers.The largest absolute movers in Main were ArcelorMittal (+15bps), Glencore International AG (+10bps), and Banco Espirito Santo SA (+9.75bps) in the underperformers, and Imperial Tobacco Group Plc (-1.54bps), GDF Suez (-1.18bps), and TNT N.V. (-1.07bps) in the outperformers.
The biggest percentage movers in XOver were Cable & Wireless Plc (+7.83%), Ladbrokes plc (+6.98%), and GKN Holdings Plc (+5.17%) in the underperformers, and International Power Plc (-10.62%), ISS Holding A/S (-3.48%), and BCM Ireland Finance Ltd (0%) in the outperformers.The largest absolute movers in XOver were Cable & Wireless Plc (+31.03bps), TUI AG (+29.19bps), and Codere Finance SA (+28.36bps) in the underperformers, and International Power Plc (-18.05bps), ISS Holding A/S (-17.73bps), and BCM Ireland Finance Ltd (-0.06bps) in the outperformers.
In the names of the HY index, the biggest percentage movers were Weyerhaeuser Co (+5.82%), Tyson Foods Inc. (+5.8%), and Gannett Co., Inc. (+5.51%) in the underperformers, and First Data Corp (-2.18%), Clear Channel Communications Inc (-1.42%), and Realogy Corporation (-0.67%) in the outperformers. The largest absolute movers in HY were MGM Mirage Inc (+44.44bps), K Hovnanian Enterprises, Inc. (+38.34bps), and Energy Future Holdings Corp. (+37.57bps) in the underperformers, and First Data Corp (-27.08bps), Clear Channel Communications Inc (-22.41bps), and Realogy Corporation (-8.49bps) in the outperformers.
The CDR Counterparty Risk Index Series 2 (of brokers and banks) rose 4.23bps (or 3.5%) to 124.93bps. Goldman Sachs Group Inc (8bps) is the worst (absolute) performer among the banks/brokers of the CDR Counterparty Index, whilst JP Morgan Chase & Co. (8.38%) is the worst (relative) performer. Dresdner Bank AG (-6.01bps) is the best (absolute) performer among the banks/brokers of the CDR Counterparty Index, and Dresdner Bank AG (-6.45%) is the best (relative) performer.
The CDR Aussie Index fell -0.09bps (or -0.09%) to 95.73bps. SingTel Optus Pty Ltd (2bps) is the worst (absolute) performer, whilst Telecom Corporation of New Zealand Limited (3.7%) is the worst (relative) performer. Westfield Trust (-2.74bps) is the best (absolute) performer, and Commonwealth Bank of Australia (-2.57%) is the best (relative) performer.
The CDR Asian Index rose 0.7bps (or 0.66%) to 106.64bps. CNOOC Limited (12.03bps) is the worst (absolute) performer, whilst CNOOC Limited (19.14%) is the worst (relative) performer. Promise Co Ltd (-7.27bps) is the best (absolute) performer, and Mitsui Sumitomo Insurance Co Ltd (-3.92%) is the best (relative) performer.
Movers in Detail
Spreads were broadly wider in the US as all the indices deteriorated. IG trades 8.7bps tight (rich) to its 50d moving average, which is a Z-Score of -1s.d.. At 104.75bps, IG has closed tighter on 133 days in the last 414 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 46.6bps wide (cheap) to its 50d moving average, which is a Z-Score of -1.2s.d. and at 546.98bps, HY has closed tighter on 72 days in the last 414 trading days (JAN09).
Indices typically underperformed single-names with skews widening in general as IG's skew decompressed as the index beat intrinsics, HVOL underperformed but widened the skew, ExHVOL outperformed but narrowed the skew, HY intrinsics beat and the skew tightened.
Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY outperformed by around 1.2bps (or 9%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 5.3bps (~ 40%), and stocks outperformed IG by an equivalent 1.1bps (~ 40%) - (implying IG underperformed HY (on an equity-adjusted basis)).
The names having the largest impact on IG are AT&T Mobility LLC (-0.5bps) pushing IG 0bps tighter, and Anadarko Petroleum Corp. (+37.5bps) adding 0.28bps to IG. HVOL is more sensitive with CenturyTel, Inc. pushing it 0bps tighter, and GATX Corporation contributing 0.42bps to HVOL's change today. The less volatile ExHVOL's move today is driven by both AT&T Mobility LLC (-0.5bps) pushing the index 0.01bps tighter, and Anadarko Petroleum Corp. (+37.5bps) adding 0.36bps to ExHVOL.
The price of investment grade credit fell 0.12% to around 99.8% of par, while the price of high yield credits fell 0.53% to around 98.13% of par. ABX market prices are lower by 0.06% of par or in absolute terms, 0.07%. Volatility (VIX) is up 0.23pts to 22.37%, with 10Y TSY rallying (yield falling) 6.9bps to 2.76% and the 2s10s curve flattened by 6.1bps, as the cost of protection on US Treasuries rose 2.4bps to 44.255bps. 2Y swap spreads tightened 2.6bps to 18.19bps, as the TED Spread tightened by 1bps to 0.26% and Libor-OIS improved 1.1bps to 22.2bps.
The Dollar strengthened with DXY rising 0.21% to 80.87901, Oil falling $1.22 to $80.26 (underperforming the dollar as the value of Oil (rebased to the value of gold) fell by 1.7% today (a 1.29% drop in the relative (dollar adjusted) value of a barrel of oil), and Gold increasing $2.45 to $1203.8 as the S&P is down (1119.3 -0.56%) underperforming IG credits (104.75bps -0.12%) while IG, which opened wider at 104bps, outperforms HY credits. IG13 and XOver13 are +1.5bps and +12bps respectively while ITRX13 is +2.75bps to 105.5bps.
Dispersion rose +2.6bps in IG. Broad market dispersion is less than historically expected given current spread levels, pointing to a more sanguine view of credits as investors discriminate less between names, with dispersion decreasing more than expected today indicating a less systemic and more idiosyncratic narrowing of the distribution of spreads.
44% of IG credits are shifting by more than 3bps and 58% of the CDX universe are also shifting significantly (more than the 5 day average of 38%). The number of names wider than the index increased by 1 to 54 as the day's range rose to 2.5bps (one-week average 3.05bps), between low bid at 103.5 and high offer at 106 and higher beta credits (2.98%) outperformed lower beta credits (3.13%).
In IG, wideners outpaced tighteners by around 19-to-1, with 113 credits wider. By sector, CONS saw 89% names wider, ENRGs 100% names wider, FINLs 95% names wider, INDUs 96% names wider, and TMTs 75% names wider. Focusing on non-financials, Europe (ITRX Main exFINLS) outperformed US (IG exFINLs) with the former trading at 101.25bps and the latter at 98.27bps.
Cross Market, we are seeing the HY-XOver spread decompressing to 65.98bps from 64.53bps, but remains below the short-term average of 69.93bps, with the HY/XOver ratio falling to 1.14x, below its 5-day mean of 1.15x. The IG-Main spread decompressed to -0.75bps from -0.75bps, but remains below the short-term average of 0.44bps, with the IG/Main ratio rising to 0.99x, below its 5-day mean of 1x. Among the HY names, we see higher risk names (>500bps) underperforming lower risk (<500bps) names. In the IG names, we see higher beta names outperforming lower beta names.
In the US, non-financials outperformed financials as IG ExFINLs are wider by 2.9bps to 98.3bps, with 4 of the 106 names tighter. while among US Financials, the CDR Counterparty Risk Index rose 4.16bps to 124.87bps, with Banks (worst) wider by 6.08bps to 116.17bps, Finance names (best) wider by 10.24bps to 378.15bps, and Brokers wider by 6.83bps to 176.17bps. Monolines are trading wider on average by 48.72bps (0.68%) to 2315.94bps.
In IG, FINLs underperformed non-FINLs (3.36% wider to 3.04% wider respectively), with the former (IG FINLs) wider by 5.2bps to 159.1bps, with 1 of the 19 names tighter. The IG CDS market (as per CDX) is -0.9bps rich (we'd expect LQD to outperform TLH) to the LQD-TLH-implied valuation of investment grade credit (105.63bps), with the bond ETFs underperforming the IG CDS market by around 2.25bps.
In Europe, ITRX Main ex-FINLs (outperforming FINLs) widened 2.19bps to 101.25bps (with ITRX FINLs -trending wider- weaker by 5 to 122.5bps) and is currently trading at the wides of the week's range at 100%, between 101.25 to 94.27bps, and is trending wider. Main LoVOL (trend wider) is currently trading at the wides of the week's range at 100%, between 90.5 to 82.87bps. ExHVOL outperformed LoVOL as the differential compressed to -0.97bps from -0.04bps, but remains below the short-term average of 0.93bps. The Main exFINLS to IG ExHVOL differential decompressed to 11.72bps from 10.64bps, but remains above the short-term average of 10.24bps.
The Emerging Market index is 0.3% less risky (0.7bps tighter) to 226.7bps. EM (Trend Wider) is currently trading at the wides of the week's range at 85.57%, between 227.4 to 222.8bps. The HY-EM spread decompressed to 320.24bps from 306.13bps, and remains above the short-term average of 312.74bps, with the HY/EM ratio rising to 2.41x, above its 5-day mean of 2.39x.