This page has been archived and commenting is disabled.

Goldman Furiously Selling Spanish Government Bonds To Clients As Its Fourth "Top Trade For 2013"

Tyler Durden's picture




 

Yesterday we presented Goldman's first 3 Top Trades for 2013 as they come out, while also noting Goldman's recent disfatuation (sic) with gold. Today, we present Goldman's 4th Top Trade for 2013, which is, drumroll, to go long Spanish Government Bonds, specifically, the 5 year, which should be bought at a current yield of 4.30%. with a target of 3.50% and a stop loss of 5.50%. This reco comes out after the SPGB complex has already enjoyed unprecedented gains - but not driven by economic improvement, far from it - but merely on the vaporware threat of ECB OMT intervention. Of course, once the "threat of intervention" moves to "fact of intervention", everything will promptly unwind as it always does (QE was far more potent as a stock boost when it was merely a daily threat: the market's peak not incidentally occurred the day after Bernanke dropped his entire load: one simply can't move beyond infinity). And with Spain's massive bond buying cliff in Q1 2013, the days its bailout could be postponed are coming to an end.

So to summarize Goldman's posture heading into 2013: very bullish and optimistic (just as it was in December 2010 when we called them out, and months before Goldman was forced to admit it was dead wrong - as it will be this time again), while the Fed has to grow its balance sheet by $1 trillion and as the world is rapidly moving not only into a recession but with tax rates set to increase across the developed world scale. As a result, Goldman is furiously selling to clients (who are buying these up as per the Top Trades) such derivative instruments as Spanish Government Bonds, while urgently buying (clients are selling) gold. Because remember: every "Top Trade" from Goldman has two parties, and Goldman's flow-prop desk is always on the other side.

Full note from Goldman's recently promoted partner (in Goldman you make partner when you make lots of money for the firm) Fransceco Garzarelli:

Top Trade #4: Long Spanish Sovereign Bonds

  • Today’s Daily reveals our fourth Top Trade recommendation for 2013: Go long benchmark 5-year Spanish Government Bonds...
  • ....at the current yield of 4.30% with a target of 3.50% and stops on a close above 5.50%.
  • The expected un-levered total return on the trade is about 8% on a 1-year investment horizon.
  • Around two-thirds of the expected return is provided by coupon and roll-down.
  • For a more conservative expression of the trade, we recommend that investors ‘cover’ long exposure in Spanish sovereign bonds with CDS on the Kingdom of Spain.
  • A more ‘aggressive’ implementation of the Top Trade involves leveraging the view along the duration (longer maturities) or credit dimensions (regional debt).
  • If the Spanish government adopts a reactive approach in asking for external financial assistance to the ESM….
  • ….SPGBs may fall in price before eventually rallying on ECB interventions.

1. Overview

US data published yesterday were marginally better than expected, with the ISM non-manufacturing index for November up to 54.7, against a consensus of 53.5. The details of the report were generally solid, except for the weakening in the employment sub-component. The ADP employment report recorded a 118K gain in private employment. ADP estimates that Hurricane Sandy reduced the print by 86k. We maintain our +75K forecast for November payrolls, to be released on December 8.

Overnight, the Central Bank of New Zealand (RBNZ) left the policy rate unchanged at 2.5% in line with our view and the consensus. In response to recent weak data, the RBNZ has downgraded its near-term growth and inflation forecasts. However, the statement made it clear that the RBNZ is focusing on the medium term, and was more hawkish that we anticipated. We continue to see only a gradual tightening cycle, with the first hike from 1Q2014.

Today, the European Central Bank and the Bank of England hold their monthly policy meetings. In line with consensus, we do not expect changes to the policy rates or to the unconventional policy measures of the two central banks. In terms of data, Q3 Euro area GDP will be released this morning. We expect a -0.1% quarterly contraction in real terms. In the US, initial jobless claims will offer more information on the impact of Hurricane Sandy on the economic outlook for the near term.

Finally, a GS client survey of expectations for the upcoming Fed moves reveals that the majority of the 266 respondents expect Fed bond purchases to continue at a pace of US$85bn per month through the end of 2013, but project purchases to continue through early-2015 at a reduced pace of $50bn per month. As to the market impact, investors appear to be very polarized between those who think the extension of QE will steepen the curve (in the 5-year to 30-year maturities), and those who expect a flattening. The 5-to-7-year maturity bucket will remain pivotal. In our opinion, the term premium beyond 2015 (3-year forward) is too depressed: the forwards price 50bp hikes per annum in both 2016 and 2017.

2. Introducing our Fourth Top Trade Recommendation for 2013

Our baseline macroeconomic projections for 2013 feature: (i) another year of ultra-low rate policy by the major central banks, and purchases of government bonds by the Fed, the ECB and the BoJ; and (ii) further progress by the fiscal authorities in reducing ‘tail risks’ to economic growth (e.g., the ‘fiscal cliff’ in the US, funding segmentation in EMU).

Mapping these characteristics of the forecast set into financial asset prices we conclude that: (i) low (and slowly rising) benchmark government yields will depress expected returns in publicly traded pro-cyclical securities, such as credit and stocks, and (ii) deeper direct interventions by central banks in asset markets will mitigate return variance.

It is in this broad context that we introduce today the fourth of our Top Trade recommendations for 2013: long Spanish 5-year benchmark government bonds, looking for an 8% unlevered annualized return, following a (very volatile) 5% return in the year to date. As with our recommendation to go long US High Yield, we expect returns to come primarily from coupon and roll-down rather than from price appreciation.

3. Long Benchmark 5-year Spanish Government Bonds, Yield Target 3.5%, Expected Return 8%

On November 20, we initiated a recommendation to go long Spanish vs. Italian 5-year government bonds, opened at 99bp, with an initial target of 40bp and a stop on a close above 130bp. The trade is currently at 96bp, reflecting a decline of about 40bp in both 5-year Spanish and Italian yields. We now recommend dropping the short Italy leg of the trade and would position outright long of 5-year Spanish Government Bonds at the current yield of 4.30% with a target of 3.50% and stops on a close above 5.50%.

Although this trade may appear to clash with our central expectation of a further contraction in Spain’s real GDP in the first half of next year, its rationale rests on the following points:

  1. According to our valuation metrics and our economic projections for 2013, the yield differential between Spanish and German government bonds is around 1 standard deviation too high (or 40bp-60bp) in maturities between 3- and 10-years. It is important to note that the econometric framework from which these valuations are derived incorporates a ‘trend’ variable, which could switch from representing a headwind into a tailwind in 2013. Further, our estimates do not account for the potentially virtuous loopback effect between lower borrowing costs and economic/fiscal performance.
  2. The Spanish government needs to fund roughly EUR230-260bn next year, half of which through its SPGB bond program (about the same as in 2012). Our central assumption is that around a fifth of the borrowing requirement will be met by the ESM through long-term loans or participation in syndicated deals (for reference, the maximum Spain can draw under an Enhanced Conditions Credit Line is around EUR100bn). The ESM funds are likely to be pari passu to existing debt, mitigating concerns over subordination. The ECB’s open market interventions through the Outright Monetary Transactions framework in maturities up to 3-years should help to subdue return volatility - which is key to re-attracting long-term foreign investors to the market .
  3. European policymakers have shown a preference for allocating capital losses on legacy assets held by Spanish regional banks onto existing bank creditors rather than saddling the government with more contingent liabilities. The prospective transformation of Euro area official sector loans to support bank recapitalizations into bank equity will work in the same direction.

Using a 1-year investment horizon, the expected un-levered total return on the trade is in the region of 8%, around two-thirds of which provided by coupon and roll-down.

4. Variations on the Theme

Investors concurring with our fundamental analysis but looking for a more conservative expression of the trade can consider ‘covering’ long exposure in Spanish sovereign bonds with CDS. As we argued on November 8 (see: Global Markets Daily, ‘Can the EMU Sovereign Bonds-CDS Basis Normalize?’), Spanish 5- and 10-year bond yields are on average 250bp over the corresponding maturity EUR-denominated sovereign CDS on the Kingdom of Spain. We expect this ‘basis’ to gradually normalize.

A more ‘aggressive’ implementation of the Top Trade involves leveraging the view along the duration or credit dimensions:

  • The term structure of Spanish yields is very steep compared with that in the ‘core’ EMU countries, particularly in maturities between 1-year and 5-years. This is the segment of the yield curve where we expect the biggest spread compression in an environment of low policy rates. Alongside ‘maturity habitat’ considerations, this is the reason why we have decided to express the trade recommendation in the 5-year sector. Extending the maturity of the position could potentially result in a larger capital appreciation. For example, a 30-year Spanish bond trades in the low 80s, or a yield close to 6%. Going by our estimates for German yields and spread changes, we could potentially see Spanish bonds at this maturity trading at most with a 5% y-t-m by end 2013, resulting in returns between 15% and 20%. The risk to this strategy resides in the uncertainties surrounding possible shifts in seniority following the introduction of bonds carrying collective action clauses. And, more broadly, developments in the structure of European sovereign debt altogether, as discussions on a European Debt Redemption Fund progress.
  • At the sub-national level, Spanish regional government bonds also offer an interesting risk-reward opportunity. The Regional Liquidity Fund (Fondo de Liquidez Autonómica , or FLA) set up by Spain’s central authorities in mid-2012 currently assists with the deficit funding and refinancing needs of 9 autonomous communities (out of a total of 17), including three of the main regions that have tapped international bond markets (Andalucia, Catalunya and Valencia). Regions borrow from the FLA at 30bp over the Kingdom’s cost of funds in exchange for fiscal conditionality. Such explicit support, now extended into 2013, substantially reduces short-term funding shortfall concerns and improves the regions’ overall credit quality. For reference, the Community of Madrid, which has retained market access, currently borrows at levels of around 250bp over 5-year SGGPs. Investors should however consider that liquidity in this segment of the market is low.

5. Risks to the Trade Recommendation

We have recommended being long Spain at the local price lows in November, and admittedly the entry point is currently no longer as attractive. Nevertheless, if our assumptions on the broader investment landscape are anywhere close to the mark, relatively high coupons in a liquid government bond market potentially backstopped by the ECB should be in demand.

The main risks to the trade revolve around the difficulties the Spanish authorities could encounter placing government bonds in the issuance-heavy first quarter of 2013, especially amid ongoing economic uncertainty. Should the Spanish authorities adopt a ‘reactive’ approach in asking for external financial assistance (i.e., applying for an Enhanced Conditions Credit Line from the ESM), SPGBs may fall in price before eventually rallying back on ECB’s interventions. A downgrade by one of the CRAs to below Investment Grade could amplify these pressures (Spain is currently rated Baa3, BBB minus, BBB by Moody’s, S&P and Fitch respectively).

Whilst these are important considerations, we are of the view that such a scenario of spread widening in Q1 2013 is now the consensus. According to anecdotal information, positioning in Spanish bonds outside Spain is generally light, especially compared with that on Italian BTPs (foreigners currently hold 20% of the stock of Spanish debt, from a peak of 60% before the crisis). For reference, Spain’s weight in 3-5-year benchmark EUR government bond portfolios is around 12%.

We have set a stop loss on the trade at 5.5%; on a 1-year holding horizon this would erase returns from ‘carry’.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Thu, 12/06/2012 - 08:40 | 3038727 GetZeeGold
GetZeeGold's picture

 

 

Those poor Muppets......gonna be even mo po now.

 

You know you're poor when you can't afford the "or" anymore.

Thu, 12/06/2012 - 08:45 | 3038734 ParkAveFlasher
ParkAveFlasher's picture

Pay no attention to the stainless steel drains beneath you, and the men in splatterproof suits.  We are here to satisfy you.  Now, kindly keep the line moving towards the conveyor.

Thu, 12/06/2012 - 09:51 | 3038928 SeverinSlade
SeverinSlade's picture

Any muppet that willingly does business with GS deserve whatever they get...One only hopes that the gold the muppets are selling is of the paper variety...But being the muppets GS clients are, that's pretty much assured.

Thu, 12/06/2012 - 11:31 | 3039302 icanhasbailout
icanhasbailout's picture

 Spanish bonds in my Wall Street casino...

Thu, 12/06/2012 - 08:46 | 3038740 economics9698
economics9698's picture

Where do these people come from? 

Thu, 12/06/2012 - 08:53 | 3038758 kliguy38
kliguy38's picture

From Oz of course. Its a land where everything is possible .....water can be turned into wine and shit into caviar. The Wizard knows all. Just realize as a peep you should NEVER question the Wizard and NEVER pull the curtain back. Now back to the Today Show and CNBS.

Thu, 12/06/2012 - 09:02 | 3038775 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Would they exchange toilet paper for Spanish bonds? That is about an equivalent exchange.

Thu, 12/06/2012 - 09:22 | 3038825 XitSam
XitSam's picture

<- Sorry.

<- We made buck off of you.

What a GS broker says to you when his recommendation turns out to be 100% wrong.

Thu, 12/06/2012 - 08:39 | 3038728 Who is John Galt
Who is John Galt's picture

Sounds like a SHITTY deal!

Thu, 12/06/2012 - 08:43 | 3038729 GetZeeGold
GetZeeGold's picture

 

 

Make sure you burn that email message before you go home Biff.

Thu, 12/06/2012 - 08:45 | 3038735 mjorden
mjorden's picture

What's the worse that can happen? no seriously ...

Thu, 12/06/2012 - 08:54 | 3038761 JPM Hater001
JPM Hater001's picture

Andy Dick makes a comeback.

Thu, 12/06/2012 - 08:54 | 3038763 JPM Hater001
JPM Hater001's picture

Or did you want me to stick to finance?

Thu, 12/06/2012 - 09:10 | 3038791 hapless
hapless's picture

Nobody there to take them off your hands when they hit 5.5?

Thu, 12/06/2012 - 08:45 | 3038737 caimen garou
caimen garou's picture

stupid is as stupid does!

Thu, 12/06/2012 - 08:45 | 3038738 Disenchanted
Disenchanted's picture

 

 

Shitty Deals R Us...

 

Should be:

 

Goldman Furiously Selling Spanish Government Bonds To Muppets As Its Fourth "Top Trade For 2013"

 

Thu, 12/06/2012 - 08:45 | 3038739 Sheeple Shepard
Sheeple Shepard's picture

So sell your gold and buy Spanish bonds?

Ok,and while your at it sell your medicine and buy A.I.D.S.

Thu, 12/06/2012 - 08:48 | 3038745 GetZeeGold
GetZeeGold's picture

 

 

I almost did.....but in my hesitation I figured I was too late.

Thu, 12/06/2012 - 08:47 | 3038741 negative rates
negative rates's picture

The pain in Spain falls plainly in Maine. 

Thu, 12/06/2012 - 08:53 | 3038759 JPM Hater001
JPM Hater001's picture

Wouldnt be easier to just raise rates?  Less Jail time in that.

Thu, 12/06/2012 - 08:54 | 3038762 rsnoble
rsnoble's picture

Let's see, loan $ to an entire region ready to go up in smoke. Brilliant.

Here is a great link that I think many of you could find beneficial.  I am not getting paid to share this, I am doing you a favor.

http://www.youtube.com/watch?v=Cf3R3yzEn94

If that perks your interests I invite you to continue along and read and sign the Non-Job Declaration of Independence.

I would also appreciate it if you could help get the word out.  It's apparent by all the great articles here on ZH that we are indeed needing an alternative escape route from the madness of this system and this is a great approach to doing just that.

Thu, 12/06/2012 - 08:58 | 3038769 timbo_em
timbo_em's picture

Is Goldman implying an OMT extension to 5 years and beyond or why do they suggest that the recommended 5 year bond will rally upon ECB intervention?
Not to mention that Spanish bonds have fully priced in the OMT.

If anyone follows Goldmans Top Trades or any other advice, they deserve to lose their money!

Thu, 12/06/2012 - 08:59 | 3038771 Yellowhoard
Yellowhoard's picture

Could there possibly be a stronger buy signal for gold than this?

Thu, 12/06/2012 - 09:07 | 3038784 Quinvarius
Quinvarius's picture

Gartman selling it has about an 80% chance of being the start of a major leg up at that very instant, 100% within a week.

Thu, 12/06/2012 - 09:10 | 3038790 aztec two step
aztec two step's picture

You wont be in the trading business long if you buy it at 4.30 and anticipate selling versus a 3.50 target while you stop yourself at 5.50. You are willing to lose 120 basis to make 80. There must be a typo some where.

Thu, 12/06/2012 - 09:15 | 3038807 Element
Element's picture

Didn't we already see this movie?

As I remember it poisoned lots of bank balance sheets and triggered widespread euroland capital flight.

Thu, 12/06/2012 - 09:23 | 3038827 GubbermintWorker
GubbermintWorker's picture

Yesterday was their call to sell gold and now a recommendation to buy Spain's Bonds! They sure are funny!!

Thu, 12/06/2012 - 09:24 | 3038829 HD
HD's picture

In Goldman's defense - anyone stupid enough to believe anything Goldman says deserves what they get.

Thu, 12/06/2012 - 09:27 | 3038836 GubbermintWorker
GubbermintWorker's picture

We have set a stop loss on the trade at 5.5%

 

That translates into a 5.5% + profit for the squid....moar if you're not quick enough ;-)

Thu, 12/06/2012 - 09:26 | 3038837 ziggy59
ziggy59's picture

From Underdog..."I will do as Goldman says"

Thu, 12/06/2012 - 09:32 | 3038858 q99x2
q99x2's picture

You've got to be shitting me. Goldman Sachs still has clients. I can only imagine that the word dipshit was derived therefrom. They should be locked up for doing business with GS. Arrest that ugly M'Fer Blankfeind while you're at it.

Thu, 12/06/2012 - 09:33 | 3038861 GMadScientist
GMadScientist's picture

Please hold these knives for a bit, kthxbye.

I'm callin' it: 5yr to 7.5% by Easter.

Thu, 12/06/2012 - 09:45 | 3038906 gould's fisker
gould&#039;s fisker's picture

Another bend over order from our lord and masters, cause this can't have anything to do with what used to be called markets. Goldman doesn't need clients, it has bitchez.

Thu, 12/06/2012 - 09:50 | 3038924 sbenard
sbenard's picture

Buy Bad Bonds to Bail Goldman Out!

Thu, 12/06/2012 - 09:53 | 3038930 sbenard
sbenard's picture

Believe it or not, a recruiter for Goldman told me that they won't take you as a client unless you have a net worth of at least $15 million. Now that's one rich muppet!

Thu, 12/06/2012 - 09:57 | 3038941 GubbermintWorker
GubbermintWorker's picture

Wow, if I had 15 million, I wouldn't want the Squid to even know about it!

Thu, 12/06/2012 - 09:59 | 3038953 HD
HD's picture

Gotta have enough money for them to take the bother to steal it...

Thu, 12/06/2012 - 09:59 | 3038950 Lofty
Lofty's picture

Muppets to the rescue....

Thu, 12/06/2012 - 12:17 | 3039430 deepsouthdoug
deepsouthdoug's picture

to the rescue of squid bonuses!

Thu, 12/06/2012 - 11:56 | 3039371 whotookmyalias
whotookmyalias's picture

I gotta get my Goldman online account set up. Anyone have the link?

Thu, 12/06/2012 - 13:08 | 3039587 bugs_
bugs_'s picture

"maybe detroits a good bet"

Thu, 12/06/2012 - 15:27 | 3040106 Catflappo
Catflappo's picture

As ZH would say "commented without comment":

 

Targeted upside is 80bps while the downside stop is 120bps

 

Do NOT follow this link or you will be banned from the site!