CapitalContext's blog

Very weak day in credit land, despite some strength in stocks. Significant sell-off in short-dated HY (cash and synthetic), financials net sold all day, and European sovereign risk spurts higher once again. Dip buyers notably absent in credit for now.

Stocks outperformed credit at the index level today but there was a significant shift in internals in corporate credit that provides the context for continued weakness in risk assets.

The rise in systemic risk in HY credit markets has spread to equity and IG credit markets respectively as we forecast but we see a number of other indications that are very troubling. Financial systemic risk is up 23% in two months and at eleven month highs (aside from brief spike in Jan).

Credit markets continue to show glaring concerns as European sovereign risk, global financial systemic risk, and global growth scares drive HY and IG to six month wides. The critical aspect is the potential to reverse the virtuous cycle that has maintained primary issuance - and we are indeed seeing this starting to happen.

Top-down equities underperformed credit once again as day after day we see the QE2 froth being blown off the weak recovery beer. HY credit is at its widest in six months, financials CDS are starting to crack finally, and sector relative richness in stocks is beginning to sync back to credit.

European sovereign and contagiously financial risk was the major underperformer of May but the clear preference for IG credit over all and risk aversion towards high yield credit remains worrisome. Up-in-quality and up-in-capital structure along with the new-issue/curve steepener/basis trade in IG are solid themes but the last few days have seen a mad scramble for high beta equities into month-end salvage an otherwise dismal month.

Credit markets are sending some worrying signals for risk appetites. Systemically rising spreads in HY, among other charts we highlight, suggest fixed income players are getting the post QE2 joke ahead of stocks.

Secondary bond selling continues, but seems as much about rotation into new issues as derisking for now. Equity outperformed credit on the day but we wonder whether the self-fulfilling liquidity support in corporate bond land is starting to ebb as concessions and basis contract and curves reach extreme steeps.

HY credit reached its widest level of the year today as IG and HY intrinsics are now unch YTD! Significant decompression since mid Feb in HY spreads, increasing amounts of net selling in secondary bonds, and a clear preference for up-in-quality and up-in-capital-structure leaves equity valuations looking precarious.

Bottom-up saw equity underperform credit but the S&P seemed to have a mind of its own into the last hour (as credit closed near its wides and stocks at their highs). Low beta outperformed in stocks and credit. Most notable was the huge jump in USA protection costs in the last two days!

Activity in spread land was very muted today with only a handful of names really making any moves. Equity outperformed credit but single-name credit was disappointing as up-in-quality continued. Primary issuance dominated thoughts today as 2s10s30s seemed to run S&P futures nicely up as credit ignored it.

HY credit deteriorated for the fifth day in a row (and 10 of last 12) as breadth was weak in equity and credit. Shifts in equity vol and context-based preferences for IG credit over stocks and HY credit suggest concerns are very warranted as macro data seems to confirm what credit has been hinting at for weeks.

Equities have significantly underperformed credit the last two days but have plenty of room to go before they re-sync with any kind of value. Rotation under the surface points a risk-averse crowd seeking safety and not poised to BTFD.

While equities are credit closed almost unch from last Friday but at their lows/wides of the week, there was plenty under the surface that clearly signals derisking is rife and discrimination active. HY dispersion and CMBX tranches among others point to some cyclical turning points that do not auger well.

Equities continued their path of convergence to credit's recently weak signals today as we saw the largest compression between debt and equity in two months. Up-in-quality and up-in-capital structure very evident as single-name vol rose notably.