High Yield

The US government is another $35 billion in the debt sink hole. The cost of this marginal addition to our existing debt load ($10 trillion? $100 trillion? who cares) was just 1.055%, which was gobbled up briskly at a 3.20 Bid To Cover. The bulk of the buying came from Primary Dealers who took down the highest portion of the auction, or 45.1%, since May of 2009, when PDs were responsible for 56.6% of the takedown. Indirect bidders, coming in at 40.6%, was the lowest indirect take down since January, when they were responsible for just 38%. The balance of 14.3% was left to the Direct Bidders. The Bid To Cover at 3.20 came in well above the LTM average of 3.03%.

Today's 5 Year $38 billion auction came in at a 1.995% high yield: not a record, unlike yesterday's 2 Year Auction, but still the lowest since April of 2009, when it was 1.93. The high yield came in 3.4 bps weak of the When Issued. The Bid To Cover came in at 2.58, compared to last auction's 2.71, and right on the one year average of 2.58. Direct bidders came in at 10.4%, indirects, at 34.6% were the lowest since July 2009, while primary Dealers took down the highest amount, or 55%, since July 2009 as well. Median yield was 1.925 and the low yield was 1.80%, with 18.36% allotted at the high yield of 1.995%.

The $40 billion 2 Year closed at a high yield of 0.738%, about 2 bps inside of expectations of 0.751%. The traditional bizarro day Bid To Cover came in at the second highest in history, or 3.45, lower only to the 3.63 from October of 2009. Not surprisingly, Direct Bidders once again carried the auction, taking down 21.3%, which also was just short of the second highest ever, compared to the 26.14% that the UK based "funds" took down in October of last year. The median yield came in at 0.72% and the low was 0.647%. 70.18% was allotted at the high. Primary Dealer hit ratio was 16.58%, one of the lowest ever as PDs continue to launder the Fed's dirty monetization scheme via prior auction repo cash. All in all, the farce will continue until it can't.

Lipper/AMG has announced the most recent fund flow number: in the past week high yield funds saw a $310 million outflow, bringing total year to date flows to ($365) million. This is the sixth consecutive weekly outflow and brings total cumulative withdrawals for the period to $4.6 billion - a new all time record, even worse than the 2003 inactivity stretch. In percentage-of-assets terms this translates into 4.9%, the largest such figure in five years. And after running a $5 billion YTD surplus earlier in the year, this has all now been reversed. Elsewhere, inflows were seen in loans (+$95mn) and HG bonds (+1.2bn), whereas EM debt and developed equities saw outflows of $70mn and $2.8bn respectively. Money Markets continue to bleed, with $1.3 billion in outflow in the past week. So far in 2010 MMs have lost 13% of their entire asset base. The delta between MM outflows and all other risk asset inflow is now $113 billion.

Last week was the fifth consecutive week of HY mutual fund outflows, which while smaller than the prior week's $1.4 billion, was still a material $759 million. With that the five consecutive weeks of HY outflows now stand at $4.3 billion, which is the second largest 5 week sequential outflow from HY funds in history, only better compared to the $4.9 billion in August of 2003. With the disappointing end of week performance in stocks last week, we anticipate that next week Lipper/AMG will announce another huge outflow. With this week's HY outflow, YTD flows are now just barely positive at $898 million. Yet the HY action was nothing compared to the unprecedented, if not record, outflow in domestic equities: ICI reports that the week ended May 26 had $13.4 billion in domestic equity outflows: a number the likes of which we don't recall even in the post-Lehman days. Curiously, even as flows out of all risky assets picked up, money market had yet another outflow of $11.5 billion, bringing total YTD money market outflows to $414 billion, or -12.9% of total money market assets. Ironically, the only asset class (aside from gold) outperforming this year is the dollar. Instead of keeping capital invested in cash, Americans have shifted nearly half a trillion out of the best performing asset in 2010.

It's official - high beta asset liquidations are not just on, but are accelerating. Lipper/AMG just announced that High Yield fund outflows surged yet again, after moderating in the prior week to just $378, hitting $1.35 billion. Two weeks ago, in the aftermath of the May 6th crash, HY funds saw their third biggest outflow in history losing $1.69 billion. This week's outflow will certainly fall in the top 10 of all time worst high beta capital flows. Look for ongoing weakness in distressed and high yield names in the coming week, as fears of mutual fund liquidations become pervasive.

And so another $120+ billion in coupons are gobbled up this week by the primary dealers, the Fed's UK Operating companies, and a few rich Chinese and Greenwich individuals.

• Yield of 2.815%, on expectations of 2.802%, previous was 3.21%
• Bid To Cover 2.88, highest since February's 2.98
• Direct Bidders 11.4%
• Indirect Bidders 51.1%
• Primary dealer hit ratio 19.92%

• $40 Billion in 5 Year Bonds close at 2.13% High Yield (15.05% allotted at high), compared to 2.54% previously, 2.46% average in last year, 2 bp tail from 2.11% WI at 1:00 PM
• Bid To Cover comes at 2.71, 2.75 previously, 2.58 average
• Direct bidders take down at new record of 15.0%, compared to 14.3% previously, 8.1% average
• Indirect bidders take down 40.6%, comapred to 48.9% previously, 48.6% average
• Primary Dealer Hit Ratio of 24.3%, compared to 20.3% previously, 24.6% average

• $42 Billion 2 Years close at 0.769% high yield (91.01% allotted), 0.762% expected, 1.024% previous, 0.989% one year average
• Bid-To-Cover comes in at2.93x, lowest since December 2009; prior came in at 3.03x, 3.08 one year average; with stock markets collapsing, no more need for PDs to overbid
• Indirect Bidders: 36.22%, 31.04% previous, 43.23% one year average
• Direct Bidders: 15.18%, 21.41% previous, 11.88% one year average
• Primary Dealer take down 23.06%

While some may think the carnage in stocks is bad, it is really a joke compared to the recent bloodbath in High Yield land, where (leveraged) funds are getting blown out and forced to liquidate high-beta (read: soon to be bankrupt unless they did a covenant lite refi) names en masse. Here is a good summary of the bloodbath happening beneath the surface courtesy of LoanConnector: "With the turmoil in Europe wreaking havoc on the high yield bond market, the week of May 17 saw the second largest spread widening of 2010. Spreads widened 69bp for the week and 33bp on Thursday alone."

After the event(s) of last week, risk is off, at least as indicated by capital flows. We demonstrated earlier how domestic equity funds saw a massive outflow even before the May 6th crash. Now, courtesy of Lipper/AMG we discover that the panic gripping high beta assets, specifically High Yield bonds, since the crash was the third biggest in recorded history (going back to 1992). The $1.7 billion in HY mutual outflows is the biggest flight to safety (or in this case money markets) since May 2004.

A chart comparing the relative performance of the S&P and Investment Grade (inverted spread, on the run) demonstrates that once again the equity algos have jumped the shark on the post crash rebound. While investment grade credit is only at mid-February levels, equities are attempting to retrace the entire loss from 2010 highs and are now at early April levels. As always, choose equity over credit, which is a market at least double the size of stocks, at your own risk. On the other hand, a short SPX, short IG risk convergence trade would seem a relative safe bet to pick a few bps. Of course, that's what everyone said about selling the basis trade in late 2007.

The $44 Billion 2 Year auction closed at 1.024% on a Bid To Cover of 3.03. But not thanks to foreign bidders: Indirect bidders were the lowest in a year, coming it a mere 31.04%, with a lower number record only in April 2009 when it was 28.71%. The slack was picked up by the so called Fed shadow ops/China London trading desk, with the Direct Bidders taking down a whopping 21.41%: the highest by far for a 2010 auction, and the second lowest in history with just the 26.14% in October higher.

For every question you may have on the outlook for the industrial side of the economy, especially if you are a HY analyst, here is the answer (at least from a groupthink perspective) in 167 pages.

Strong demand for the just closed $40 billion 3 Year Bond auction:

• Yields 1.776% vs expected 1.766%
• Bid To Cover strong 3.1 versus 3.13 previous and 3.05 average
• Indirect Takedown of 52.20% vs Average 54.13 (previous 52.01)
• Indirect Hit Ratio: 69.3%
• Direct Take Down: 10.8%, 10.3% previous, all time high of 23.4% in January 2010