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Midday Movers: Credit Stirring
From Capital Context
Our preferred strategy for executing the view that HY spreads were going to come under pressure is performing well from our prescient entry level.
The corporate, financial, and sovereign credit markets appear to be struggling across the board currently. We have been sounding alarm bells on the warnings these markets send and how to interpret them for over a month and hope investors have profited from them.
While we remain tactically market neutral in equities, we see further pain in credit as increasingly there are signs of what is a crowded and seemingly one-way trade starting to get spooked as primary and secondary bond markets are downright weak, CDS markets are maintaining several concerning features, and the contextual relationships between various aggregate (sector and quality cohorts) credit and equity points to deterioration in both stock and bond markets.
Our preferred strategy for taking advantage of these perspectives was the HYG-LQD weighted pairs trade. This position entered on 10/6 appears to have been very prescient and we hope readers have taken advantage of it. Our initial target was $44 and we are sticking to that for now but will raise our stop into the money at around $41. Our institutional clients remain active in several profitable strategies (as we outlined earlier this week in our Closing Context and
What We Are Looking At
) and for individual investors we continue to watch the SPY-LQD-IEF arb for a short-term trading opportunity (these have been very successful in the past).
Without reiterating the
various and lengthy discussion on both why we shifted bearish
and what we are looking at, there is little we see currently that encourages a change of thesis. Perhaps the best we can hope for is a short-term compression in credit derivative index spreads as they remain very considerably cheap (wide) of their underlying fair-value (as blanket hedge/overlay demand remains high and the relative proximity of the roll reduces willingness to cover single-name positions). We suspect this will be short-lived if we do see index compression in that it will be strength to sell into for stuck longs (index and single-name).
HY spread have crossed the 50 and 200DMA for the first time since Oct2010 and the 200DMA is close to turning upwards (wider).
This week saw both
IG and HY credit spreads move wide of their 200-day moving average
(DMA) (crossing for the first time since 10/4/10). This is not our go to indicator du jour but does signify a notable shift in trend and as the chart shows above, there has been a basing effect this time around as opposed to the rapid and more crazed reversion we saw last April/May which tested the 50 and 200DMAs only to revert.
We also note that the 200DMA is close (within a week) of turning upwards sloping should we remain at or around these levels for the next week or so. Our concern of an outright short HY position is the relative velocity with which it has moved and the cheapness to the index as we mentioned but these are relatively small size implications in the context of what we see as more of a cyclical turn in the credit cycle.
The S&P futures market remains correlated with the risk basket from yesterday but at slightly elevated levels - in the same way as we see modest outperformance of equities over credit today.
This morning,
we are seeing
S&P futures outperforming their relative risk basket peers and also the credit market
for now in HY though flat in IG. This is cyclically sensible as we tend to see an initial reaction every three to four days in the credit-equity relationship (i.e. we will see equity contract/expand relative to credit for three to four days before pausing and then trying again).
HY spreads are getting awfully close to the magic barrier of 500bps once again (and IG 100bps) and both IG and HY are at six month wides (as of today with IG).
Rising credit spreads and reduced appetite for new issues will break the
virtuous cycle
that we have discussed manifold and that weakness, as Peter Tchir for TF Advisors has pointed out, is starting to show up in new issue underperformance. Once again today we see the
up-in-quality and up-in-capital structure trades playing out with little buying interest at all in secondary HY
and focus in IG names instead.
Greek bond basis continues to compress as hedgers remain the marginal buyer of GGBs.
Much of the weakness in the US credit can be put down to the apparent macro weakness, the end of the TSY crowding out of QE2, and Bernanke's decidedly less ebulient tone but there is no doubt that
European sovereign risk issues are weighing heavily on credit markets
. Schaeuble's admission that possibly/could-be/maybe/inevitably Greece will restructure/reprofile (and you know our thoughts on this triggering low recoveries in CDS land) has seen PIIGS screaming wider in CDS today (on average 31bps wider) as Greece hits record wides in CDS (over 1475bps), Ireland +30 to 680, Spain +15 to 256, Italyy +10 to 160, and Portugal breaking 700 (to 705), wider by 28bps.
SovX is 9bps wider, with intrinsics breaking back above 200bps
, but EU financials are significantly decompressing. Financial Sub dent is 15bps off and Seniors 8bps (even as non-financials are leaking 0.5bps wider only). This shift in the Main-FINs-SovX relationship has them reverting very close to what we would call empirically fair and we suggest starting to unwind this position - especially the SovX leg.
Greek Government Bond price term structure - long-dated cheapest-to-deliver bonds may see more bid but market-based haircuts are dramatic already.
Please remember that the marginal buyers in many of the European sovereign bond markets are hedgers or CDS basis traders ensuring cover on their positions and we will continue to see the basis in the chart converge as we draw closer to the inevitable CDS trigger (whether voluntary and driven by the Determinations Committee or forced restructuring).
The CDS contract means the cheapest-to-deliver bond (and there is plenty of flexibility oin sovereign CDS) will be bid. The chart above shows the prices of GGBs currently (and their dreadful market-based haircuts already) and so
if you are told that longer-dated GGBs rallied, please note this is far less a sign of optimism and much more likely hedgies and prop desks covering any residual risk exposure
as a credit event draws nigh.
With regard to our favorite topic of recent weeks,
financials
, we note that on average
US financials in the FSB30 index crossed wider than European financials for the first time since DEC10 today
- with both very much diverged from their Asian counterparts. Overall,
systemic risk is hovering near those six month highs
with North American financials are their widest since 1/10/11.
The bottom line
is that we remain neutral on equities top-down (
based on our TAA model
), prefer short stocks relative to long credit as a medium term arb (as QE2 expires), like HY-IG decompression (whether via our HYGLQD pair or in CDS space), think best value short currently is short IG insurers vs long IG index as a low cost long vol trade, would be prepared for some short-term pain in HY as the index compresses back to fair on either an arb, the pending roll (June 20th) or pressure from the 3s5s flattener that we also think makes sense here.
Index/Intrinsics Changes for the day so far
CDX16 IG
+0.87bps to 96.59 ($-0.03 to $100.13) (FV +1.29bps to 93.65) (92 wider - 11 tighter <> 61 steeper - 49 flatter) - No Trend.
CDX16 HVOL
0bps to 154 (FV +2.26bps to 156.47) (28 wider - 0 tighter <> 13 steeper - 17 flatter) - Trend Wider.
CDX16 ExHVOL
+1.14bps to 78.46 (FV +0.99bps to 74.59) (65 wider - 31 tighter <> 47 steeper - 49 flatter).
CDX16 HY
(30% recovery) Px $-0.42 to $100.52 / +10.3bps to 487.2 (FV +9.4bps to 468.63) (93 wider - 2 tighter <> 21 steeper - 76 flatter) - Trend Wider.
LCDX16
(70% recovery) Px $-0.06 to $99.63 / +1.62bps to 282.53 - Trend Wider.
MCDX16
+1.75bps to 132.5bps. - Trend Wider.
ITRX15 Main
+1.6bps to 105.38bps (FV+2.34bps to 109.11bps).
ITRX15 HiVol
+4bps to 148bps (FV+4.02bps to 146.57bps).
ITRX15 Xover
+6.75bps to 392bps (FV+7.51bps to 380.94bps).
ITRX15 FINLs
+6.75bps to 158bps (FV+4.78bps to 156.82bps).
DXY
strengthened 0.35% to 73.78.
Oil
rose $1.38 to $100.47.
Gold
fell $6.65 to $1537.5.
VIX
increased 0.06pts to 18.08%.
10Y US Treasury yields
fell 3.8bps to 2.96%.
S&P500 Futures
lost 0.23% to 1281.8.
Spreads were broadly wider in the US as all the indices deteriorated. IG trades 4.5bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.7s.d.. At 96.59bps, IG has closed tighter on 198 days in the last 626 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 13.7bps wide (cheap) to its 50d moving average, which is a Z-Score of 3.4s.d. and at 487.18bps, HY has closed tighter on 151 days in the last 626 trading days (JAN09). Indices typically underperformed single-names with skews widening in general - notably now for a sustained period.
Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY underperformed by around 7.3bps (or 71%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 5.9bps, and stocks underperformed IG by an equivalent 0.1bps - (implying IG underperformed HY (on an equity-adjusted basis)).
Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were American International Group, Inc. (+10.5bps) [+0.08bps], Simon Property Group, L.P. (+8.5bps) [+0.07bps], and General Electric Capital Corp (+7bps) [+0.06bps], and the best performing names were Sherwin-Williams Company/The (-1bps) [-0.01bps], Dell Inc. (-1bps) [-0.01bps], and AT&T Mobility LLC (-0.5bps) [-0bps] // (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. (+119.59bps) [+0.79bps], MBIA Insurance Corporation (+94.22bps) [+0.66bps], and PMI Group Inc/The (+76.01bps) [+0.52bps], and the best performing names were Clear Channel Communications Inc (-7.82bps) [-0.07bps], CMS Energy Corp. (-2bps) [-0.02bps], and Boyd Gaming Corporation (0bps) [+0bps] // (absolute spread chg) [HY index impact].
Among the European IG names, the worst performing names (on a DV01-adjusted basis) were Nokia OYJ (+35bps) [+0.27bps], EDP-Energias de Portugal, S.A. (+19bps) [+0.14bps], and Banco Popolare SC (+18bps) [+0.13bps], and the best performing names were Rentokil Initial Plc (-3bps) [-0.02bps], JTI (UK) Finance PLC (-1.5bps) [-0.01bps], and Nestle SA (-1bps) [-0.01bps] // (absolute spread chg) [HY index impact].
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That term "smart money" facinates me...it is almost a contradiction in terms.
Overall like the call.
Not yet concerned on the HY arb compression, seeing skew at 5/8s mid and have seen it wide of 1pt at times this year.
ABS market is spooking credit as well. Seeing CDX being used to proxy hedge ABS exposure since the ABX/CMBS has gotten pounded last couple of days
Yes, hearing same. Also noted a week or two back that junior-senior tranches diverging suggesting early/smart money positioning for rising correlation or more specifically increased systemic risk ina CMBS markets. Interesting times eh...
Congrats on a great widening call