Credit Dislocated, Again

Tyler Durden's picture

We have discussed the dynamics of the credit-equity-vol relationship for many months in the hope that it broadens investment horizons and opens traders' eyes to a bigger picture of global risk appetite. Following (and understanding) the debt-equity relationship has proved, in general, a very useful instrument in an investor's toolkit and Barclay's Capital this week points to just how dislocated European credits are relative to stocks (having underperformed) and while we may not be quite as exuberant as them in the call to add credit exposure here (as we see more structural than cyclical concerns ahead), we cannot argue that on a relative-value basis, arguments for significant re-allocation from bonds to stocks simply do not make sense (from both valuation and risk perspectives) - no matter how many times Pisani tells us so.


From Barclay's Capital: European Credit On Deck:

Credit strongly underperformed equities over the past week, as the  market struggled to follow the equity rally sparked by weekend rumors about potential new sweeping initiatives to contain the sovereign crisis in Europe. While the Eurostoxx 50 has gained almost 9% since last Friday’s close, iTraxx Main is only 4bp tighter – well below the tightening expected given the recent relationship between the two indices (Figure 1). We do not see a fundamental reason for this disconnect and expect some normalization in the near term.


From a historical perspective, the current underperformance is in line with a general theme of credit underperforming equities in periods of elevated market volatility. To illustrate this effect, in Figure 2 we show the rolling average of 3-month z-scores from CDS-equity regressions for constituents of the iTraxx Main S15. Average z-score measures the extent to which current CDS spreads deviate on average  from levels implied by equity prices.


A positive value indicates that credit is trading wide relative to what the equity performance would imply (and vice versa). Over the past four years, spikes in market volatility, as measured by the VSTOXX, have tended to coincide with jumps in the average z-score, highlighting credit market’s unusually strong negative sensitivity to volatility. The most prominent of such instances include:

  • August 2007 – the beginning of the financial crisis;
  • Late 2008 – the Lehman collapse;
  • May 2010 – the first Greek bailout.

Conversely, periods of credit outperformance  have been typically accompanied by low or falling volatility. In other words, since 2007, credit has led equity markets in any downturn, even as the relationship has normalized over longer periods of time.


When broken down to the sectoral level, its  interesting to note that the recent credit underperformance has been consistent across non-financial sectors, with financials being the only sector in which CDS, on average, are trading in line with stocks. Given the close connection between sovereign solvency and bank impairments, it is not surprising that the financial sector has shown a stronger linkage in performance across asset classes. Nonetheless, the significant underperformance of all other sectors relative to equities leads us to argue that credit is poised for outperformance whichever direction the market turns from here. If the rally continues, then on a beta-adjusted basis credit has a long way to go to catch up with equities, while if market softness continues, credit widening should be limited by the fact that it is not very far from the recent (and all-time) wides at the index level.

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trampstamp's picture

Good or bad for stocks? I'd like to sell into a 4th quarter rally. Seems 2012 will be a dismal year to say the least.

JW n FL's picture



Whats wrong with you?

EVERYTHING IS BULLISH!! if you are shorting. LOL!!

Pinto Currency's picture


Using normal metrics and an anticipated economic slowdown, stocks may seem overvalued.


However, a euro crisis will quickly spread to USD and other currencies.


Then you will see the rush to gold, oil, commodities in general and, yes, equities. 


Anything but burning currencies.


snowball777's picture

Logic fail. We'll see liquidation and a further inflated bubble in bonds.

snowball777's picture

You want to play chicken with the Bernank and try to time that pop?

Avaya con dios!

Pinto Currency's picture




If you think it is logic fail, see what happened in Argentina during their currency crisis - the Merval Index surged in 2001/02 as the crisis accelerated.


Important to know your history in terms of what really happens during currency crises.  Steve Liesman and Bob Pisani  won't get you there.


Paper: "A stock market boom during a financial crisis?"


aus_punter's picture

so in Argentina investors worked out a loophole to get their assets out of pesos and exploited it


that doesnt actually seem particularly suprising

aus_punter's picture

so in Argentina investors worked out a loophole to get their assets out of pesos and exploited it


that doesnt actually seem particularly suprising

snowball777's picture

This isn't Argentina...the dollar isn't pegged to the reserve currency, it is the reserve currency. If there's a crisis in other currencies, people will run to the most liquid market in the least fucked currency which, sad to say, is the dollar after the Zooro tanks.

I'll buy your argument about commodities...they'll ramp in every currency, but money rushing out of the Zooro into dollars will find its way to bonds, not the crashing values of the stock farce.

From the paper:

"...the rise in Argentine stock prices as a result of investors using the stock market to circumvent cash withdrawal restrictions at banks and shift funds
out of Argentina (and pesos) into the United States (and dollars)."

Where do you think USD denominated stocks will allow people to move their dollar assets to exactly? It was a boom for the Argentine stock market, not the US.

Quinvarius's picture

It isn't a logic fail.  There is too much money floating around and it is all in the banking system.  It will be spent on banker stuff.  The logic fail is looking at a manipulated Treasury market as the credit baseline while the rest of credit is dumping.

snowball777's picture

Do note my use of the word 'bubble'. Whether it is a good long-term investment is almost beside the's liquid and it's huge.


redpill's picture

With so much distortion from central banks in the global economy, nearly everything gets "misallocated" to one degree or another. Then you have every financial talking head trying to make sense of all the gibberish and distorted noise that the market vomits out each day, desperately clinging to various complex theories that fit the circumstances for 24-48 hours, after which it seesaws back again in a chaotic swoon.

It's annoyingto have to listen to, and conversely the clarity and consistency of ZH is what makes it a breath of fresh air in the daily stink of the Keynesian endgame.

JW n FL's picture



Keynesian endgame

Keynesian, Austrian and / or other.. is NOT! the problem.

Corruption is the Problem..

Austrian Economics is just another way to leave the Corrupt Super Structure in place.. and considering that there are to, too many of YOU!

That is the real issue..

YOU! breath to, too much air..

YOU! use to, too much oil..

YOU! are tapped out and no longer useful to milk or drain for imagined future production..

and because of these things (and others) You! must now kill other worthless tapped out people.. OR?!?!? Be killed by other worthless tapped out people.. no one is forcing You! and You! have a Choice, kill or be killed.

I am sorry that You! are not part of the lucky sperm club..

I am sorry that You! are not important enough for someone who is of importance to want or need You! to stay alive.. You! should have been a better boot licker or more productive, sorry.

Not everyone is a winner or a tiger blooded double winner even!

Not everyone can have a D.O.D. number.. if everyone had one they wouldn't be special!

If you feel special because I have said You! so many times.. I promise You! that You! are NOT!!

My use of You! is so that all of YOU! that lack a D.O.D. Number (of importance) will better understand what Your! new place is in this World!


But on the upside.. You! ALL!! can always turn on Cable (Feel Great) News and thusly forget about all this ugly truth.. that you don't believe in any way.


Everyone who doesn't understand the numbers of Population Control should really get a fucking pencil out and do some simple math, let this old fucker help you along if you are to fucking dense to pull off the exercise by yourself.


The Most IMPORTANT Video You'll Ever See (part 1 of 8)


and is AL doesn't make a case clear enough, let Bill Gates help!


Bill Gates-Population Reduction Agenda of the Earth


or if Bill Gates alone doesn't bring it quite into view let Rockefeller help!

and if that doesn't work for you, then you are part of the problem.


David Rockefeller Speech on Population Control



redpill's picture

Corruption is inevitable, so to say it is the (only) problem is to complain the sky is blue. However you can limit that corruption by virtue of limiting centralized power. That is when you can distinguish between a realistic economic policy backed by sound money, and one that is based on illusion and endlessly inflatable fiat. Sound money prevents it's own debauchery much more effectively, and an economic approach that values underconsumption, saving, and production is going to have more capable and vigilant participants than one that is based upon imaginary credit, handouts, and debt-backed consumption.

LowProfile's picture

Thanks, I started to try and respond but immediately got a cluster headache.

JW n FL's picture



I could comment.. about your ability to comprehend.. or lack of.. but is it really needed  after what you said about yourself?

JW n FL's picture





Which handouts bother you more?

helping the poor negro's?


helping all those poor starving wall street, Triple "A" Rated Corporations?

be honest?

is it the illegal's?

or is it the Trillions we pass out around the world..


are those POOR Corporations going to suffer because the Negro's and Mex-e-cans are stealing all of you tax dollars?

I bet that 99% of the austrian crowd deep down inside believes that it is all the poor, generational welfare families that are a drain on this country..

or maybe that Grandma and Grandpa are now the worst of the worst, with regard to draining the life blood from America!


Come on.. be honest! it's the internet.. you are anonymous! no one knows you real name.. tell the truth tea bagger!

if you can't say nigger now when will you grow a set big enough to say it later?

do you need a crowd of fellow nigger haters around so that you feel superior in number?

politics is dead, the sooner you figure that out.. the happier you will be.



Pinto Currency's picture




It may be too late, but park it before you wreck it.

Come back in the morning.

hardcleareye's picture

Hey I'm kinda enjoying JW's rant.  I am reading it with a very heavy layer of sarcasm to the words and it kinda makes sense. 

The short coming of blogs is that you can't hear the tone of voice or the body language that goes with the words....

lasvegaspersona's picture


drunk or are those your true colors?

Withdrawn Sanction's picture

Ah yes, Professor Bartlett's grandiosely titled ode to linear thinking.  True, his arithmetic is parabolic, but his conclusions are still just linear extrapolations from that parabola.  And indeed, his arithmetic is correct as far as it goes.  But that's the trouble, he makes no allowance for discontinuities, resets, innovation, learning, nothing.

Anyone calling for population reduction who does not first put his call into personal practice is at best a hypocritical poseur, and at worst a would-be murderer.

hardcleareye's picture

I think you missed the point of JW in FL.

junkyardjack's picture

This is how the market will operate from now on.  There will be a big crash, hedge funds will go out of business because of redemptions and high watermarks.  Then new ones will open up, the market will rally on leveraged volume.  As everyone figures out that there is no one else to buy because everyone is leveraged out, repeat market crash. And so on and so on.  Just ride the wave

LawsofPhysics's picture

Exactly, and with ZH's help we will all get great rides and peel off the back of the wave before crashing on the rocks.  Now get back into the line-up and wait your turn.

snowball777's picture

Don't forget to leash your board. Could get choppy.

oldman's picture


no one cares about the future

here and now, baby

leave it alone; it will manifest itself             om

DormRoom's picture

It's kind of like a Phillips curve for credit-equities.  Equity markets can't go up without more debt in the sytem.  The less debt in the system, equity markets go down. 

Conclusion: Greenspan's Great Moderation was rooted on leverage, and debt expansion.  Now we return to cycles of more frequent boom-bust as economies adjust back to real conditions.  More debt implies even greater adjustment shocks in the near future for world economies.

Surly Bear's picture

The fact that I understand you scares me.

css1971's picture

Yes. It is a pyramid scam.


Hence "The Great Ponzi".


And I reckon the pyramid on the dollar bill.

JW n FL's picture



should be limited by the fact that it is not very far from the recent (and all-time) wides at the index level.

There will be a continuing tightening going forward, beyond the new year.

CrashisOptimistic's picture

People just do not understand.

We are paying more than $100/barrel for oil at the refineries.  This has been true all year.

Nothing can be done about this.  There are no historical precedents.  

A lot of people are going to die, soon.

DormRoom's picture

With the EZ about to implode, and uncertainty in EURO continuity, everyone is unwinding USD and YEN carry trade, in case of huge inflows to these currencies, and away from EUR (likely reason for the central bank swap lines).  So more USD strength.  Gold is not a safe haven investment, or liquid enough for panic reallocation.


'Analysts' told ppl to hold when the tech bubble crashed.  Analysts told ppl to hold when the real estate market crashed.  Analyst are telling ppl to hold on to silver & gold, when they may crash.  Most of the recent demand in precious metal was from hedgefunds & institutions using it as a financial asset (hedge).  They weren't playing it as a currency alternative.  When they exit their hedge positions gold & silver will collapse, and retailers will be wiped out.  retails will not get a bailout.

GeneMarchbanks's picture

Hedge funds are old news my friend. Nobody cares what they do anymore as we'll likely see the hf industry cut in half over the next few years. This snap to the USD will leave people asking themselves 'what's next?' At this point we'll have to wait and see but if you think hyper-deflation, then, for your sake, I hope you're wrong. But even then, I'd rather own gold bars in order to have something to throw at the armed barbarians looking for blood.

jekyll island's picture

I agree, at some point there will be a mass exodus from bonds and gold will benefit.  Buying PMs is a proxy for shorting fiat currencies.  

It seems that there are only two places to be in the current credit environment:  

1)  Free and clear with no debt - the most desirable option

2)  In hock to your eyeballs with the banks looking the other way when you cannot pay


It would be risky, but if you cannot get out of debt, why not take on more?  It is clear that inflation will increase and interest rates will rise, maybe substantially.  Taking out a loan at the current suppressed interest rates and paying it back with inflated dollars is essentially shorting the dollar, albeit on margin.  Tapping a home equity line of credit and buying PMs would be one example.  If there is hyperinflation, you could pay off all your debt by liquidating a portion of your gold and keep the remainder.  If there is deflation....well that would be the wrong side of the trade.  

Mike2756's picture

Pm's have a long way to drop still. Gold hasn't touched it's 100 sma (monthly) since apr 2003 (now at 800), silver did in oct 2008 (now around 15). I would think gold holds in the 1k area if silver spikes under 20.

Pegasus Muse's picture

Huge demand for Physical Metals will help support the POG/POS.  Listen to Bill Haynes and Dan Norcini on this week's KWN broadcast.


The KWN Weekly Metals Wrap - We have added new segments to the KWN Weekly Metals Wrap covering gold, silver, trading and a plethora of other factors affecting the precious metals markets.  We Cover the Commitment of Traders Report in detail as well as a number of other factors which can influence the gold and silver market price action.


Mr_Wonderful's picture

Markets will reopen more quickly during flash crashes to make them more efficient for HFT plundering:

"The U.S. Securities and Exchange Commission began an overhaul of rules adopted a quarter century ago to shut down the stock market and related futures trading during periods of volatility, proposing that curbs be triggered when the Standard & Poor’s 500 Index falls 7 percent.
The changes would switch the index used for circuit breakers to the S&P 500 from the Dow Jones Industrial Average, according to proposals submitted by U.S. equities exchanges and the Financial Industry Regulatory Authority. Index declines that set off halts in stocks, options and futures would be reduced and their duration shortened, according to a summary of the proposals from the SEC.
“Tighter circuit breakers and a coordinated effort will allow everyone to take a breath when it’s needed,” William Karsh, a consultant and former chief operating officer at Jersey City, New Jersey-based Direct Edge Holdings LLC, said in a phone interview. “If they stop trading and give people a chance to assess what’s going on, they can reopen without the crazy whipping action we saw on May 6, 2010.” (Source)
Schmuck Raker's picture

"“Tighter circuit breakers and a coordinated effort will allow everyone to take a breath when it’s needed,” William Karsh, a consultant and former chief operating officer at Jersey City, New Jersey-based Direct Edge Holdings LLC, said in a phone interview. “If they stop trading and give people a chance to assess what’s going on, they can reopen without the crazy whipping action we saw on May 6, 2010.”"

Maybe PEOPLE are not the problem that needs to be addressed.

What happens if/when HFT algos start trading again after these breaks: the break will be in the news, the trip is bad news, HFTs sell, trip the next breaker, etc.?

Mr_Wonderful's picture

Shorter halts would favor the programs, I imagine.

snowball777's picture

There's a tacit assumption here that selling is irrational. It's not.

If we periodically lock the doors to the burning theater, people will leave in a more orderly fashion...

RobotTrader's picture

Puplava is ultra bearish.

After listening to the podcast, most guys are likey to pile into the 3x Triple Whammy ETF's like TZA, FAZ, VXX, etc.

Too bad Puplava personally invested heavily in hybrid cars, solar panels for his house, etc.

Looks like he won't need those any time soon.


levelworm's picture

I agree. It's just like before (the 79 and 29), but with different tools and faces. Gold will collapse and USD will dominate, while the other countries scramble to find more USD, they have to buy it at a much higher price from US. And if they cannot pay the price, a pound of flesh has to be provided.

LowProfile's picture

"while the other countries scramble to find more USD, they have to buy it at a much higher price from US."


Seems to me they'll just dump their US treasurys on the FED!

Stoploss's picture

I see the 30 yr has taken out the highs from Oct - Dec '08 . Me thinks with the twist in effect tomorrow, that won't be enough to discourage flight to the 30, given the credit uncertainty in the last 60 days, not to mention everything else. My "Laslo B" ruler analysis shows the 30yr could go to over 200??  Which means that TBT goes to under 10?

TBT is #1 in the short screens, and TLT is number one, in the long screens i run.

Decisions, decisions, any thoughts? 


jekyll island's picture

Levelworm makes a good point about the previous history of PM spikes, but this time I question the resolve of the Bernank to raise interest rates to defend the dollar when inflation hits hard.  Current service of US Gubmit debt is about 19% of budget, if interest go to 10% it would triple and half of every tax dollar collected would go to pay interest.  Since the government already pays 50% of all collections to entitlements, there would be nothing left for discretionary spending.  Can you imagine a sitting US Congress not spending anything? Me either, they would demand that the Fed print more FRN$, making the problem worse, eventually entering the death spiral.  

So with that logic, shorting bonds would seem like a tremendous opportunity.  Key word is seems.  Hard to go up against someone with unlimited resources and win.  Everyone who has tried shorting bonds so far has been destroyed.  I think eventually bonds are going to tank and it will be gruesome.  Holding a short position in bonds right now has been gruesome too.  Might be a good idea to just stay away.  If you want to play it, I would suggest buying put options far out of the money on TLT for cheap price.  Limiting your downside risk is very important here, buying and holding RRPIX will tie up a lot of capital and expose it to an irrational market.  Options can and do expire worthless, but betting $1,000 on options is safer than putting $10,000 into a bear bond fund and watching it shrink because the sheeple are panicking.