Anatomy Of A Squeeze
While little has really been said or done this week with regard to solving any of the structural issues facing Europe, macro data globally has hardly been encouraging, and micro (earnings) have not aggressively beaten earnings, the equity and credit markets have ripped higher. While many have talked of short squeezes, which obviously are at the heart of every trend turn (whether micro or macro), we thought it useful to get some context on this move to judge when/if it will ever stop.
The move started last Friday but really ramped up starting late Wednesday when we saw equities tear away from any other asset class. This was quickly seen through but then as we got no cataclysmic news, we drifted higher once again and Thursday saw a similar picture where equities were aggressively bid - much more so than HY and IG.
What is notable is that HY was in fact dramatically more cheap than equities still and would have been the long of choice for any sophisticated trader looking to add beta exposure to his book - given the relative cheapness. This also eschews the asset allocation rotation argument as HY should have led as it had become so cheap - this feels like an equity index-driven chase as opposed to risk appetite-driven (and volume helps to confirm that). Sure enough equities screamed higher outperforming HY which in turn outperformed IG (these are risk premia NOT yields). Today saw a similar story once again - equities over HY over IG.
But there are a few things that make us wonder if this short squeeze is running its course.
First, empirically we have seldom seen the kind of price action in this chart occur for more than four days in a row - this is anecdotal but until we see HY really start to participate and catch up to equity's exuberance - we remain of the opinion that this is squeeze-driven.
Second, credit indices have compressed to their single-name-based fair-value and the difference between the index and its fair-value has compressed massively this week. It would seem that all the macro hedge overlays have been removed leaving the market long and prone to correction on any disappointment: e.g. HY -85bps since Friday vs -32bps for the HY fair-value, IG -9.5bps vs -5bps for the IG fair-value this week.
Third, since Friday, equities have outperformed HY and IG by around 7-8bps equivalent - a shift that is relatively unusual and prone to rapid reversion.
Fourth, concessions on new issues remains high - hardly a signal that risk appetite is really back (e.g. TXT 5Y came 50bps or $2 cheap to market-implied expectations this week).
Fifth, implied correlation remains high in the equity options market even as VIX drops into OPEX - this tends to mean professionals remain more worried from a systemic perspective than the headline VIX moves would suggest.
Sixth, distributional analysis of the SPY options market shows that skewness and kurtosis remain implied at levels indicative of concern at large tail risk to the downside - even as short-term these have reduced - these are levels that are very hard for a retail trader to actively position to benefit from - even as skews have flattened with levels.
Seventh, a longer-term CONTEXT (risk-basket-based analysis of where ES should trade) shows three areas of equity squeeze in the last week and also indicates that equities remain notably expensive relative to risk assets in the short-term (this is as opposed to the more typical daily re-calibrated CONTEXT model).
Of course, who knows when this will end (if it will end) but we are confident that Birinyi's ruler will have to bend to the will of a macro and systemic environment that simply does not look good and is marginally priced into credit and equity markets.
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