Having seen the supposed smart money miss out on the October rally in US equities, the last few days have once again surprised many with US equity performing similarly each day and ramping to close at its highs - each time notably ahead of credit markets and broad risk markets. From the early October lows, we have seen the rotation from US to Europe reverse with the last few days see US equities dramatically outperform European. We wonder, somewhat prosaically, whether the relative inaction of the ECB with regard to BTP intervention since early Friday morning is what pushed Berlusconi over the edge and US-Europe divergence to extremes as Draghi flexes the ECB's considerable muscles.
Critically, we see low volume ramps in the afternoons which leave every other market trailing in the dust - only to leak back in the overnight sessions. Couple this extraordinary action in S&P futures with the MF Global SIPC news and we wonder what liquidation will impact next?
Initially we saw European equities outperforming US as we squeezed off the lows in early October. The last few days have seen recession fears rise and systemic risk explode in the Euro zone which appears to have forced rotation into the US equity market - which of course will remain unscathed.
However, it is the similarity of the performance of the last few days that is wonderful - presented with little comment except to say - with all the fund flows and the relative cheapness of HY as an asset class still, we are shocked it has not led this risk-on rally - or perhaps it provides just the right amount of reality to keep us from chasing tails.
And to put the strength in ES into perspective - we note the difference between CONTEXT (the broad risk-asset based index) and ES grew very large this afternoon as FX, TSY, commodity, and credit markets golf-clapped while equities screamed...
Swissy rallied notably today, as did JPY but for much of the afternoon EUR tracked very flat and DXY went nowhere. TSYs were sold relatively hard and the 2s10s30s fly humped quite significantly from 71bps to 79bps - a major driver of risk today. Secondary bond markets saw notable net-selling though between the sell-off in TSYs and new issuance this is understandable.
Interestingly, Financials were the only sector that saw net buying today - we have been pointing to the underperformance of financials CDS relative to stocks for a few days now and while today's action was heavy, we suspect the basis traders were back in town - buying bonds against buying protection as the spread has opened up (and playing in sovereign basis has too much event risk). There was also clear duration-reduction across maturities.
The basis trade perspective on CDS vs bonds in financials could also help explain the very large divergence between equities and CDS for some major financials recently - for example Morgan Stanley:
Gold fell post-Berlusconi (after cracking $1800) and Oil spurted to $97 in the late trading.