Financials Surge Again As Post-Europe-Close Credit Outperforms
Today saw NYSE trading volumes at their 3rd highest of the year and ES (the e-mini S&P 500 futures contract) saw its second highest volume of the year (though both still well below recent averages) as stocks managed marginal gains, outperformed handily by high yield credit. For the sixth day of the last seven ES closed only a smidge from where it opened but average trade size was dramatically higher (its highest since 8/31) which historically has suggested a short-term top (and certainly seems odd heading into tomorrow's European bond auctions). In a similar manner to yesterday, HY17 (the high yield credit index) surged (absolute and relative to ES and HYG) from the European close to US day session close (index RV to Europe and Index arbitrage seems much more of an effect than rerisking. The major Financials were among the best performers today once again (as XLF managed +1.13%) with BofA now up an impressive (if not ridiculous) 24% YTD (and Citi +19%). Perhaps of note is the fact that the major financial CDS rally stalled today with MS, GS, and JPM all leaking a little wider into the close. Treasuries continued their ain't-no-decoupling rally as the 10Y auction went well (beige Book mixed/weak) leaving longer-dated TSY yields near day (and year to date) lows and ES near day highs (sell EUR, buy anything USD-denominated?). The dollar is practically unchanged on the week now as EUR 1.27 (and GBP more so) weakness dragged it up (even as AUD rallied - helping stocks). Copper outperformed among the economically sensitive commodities as Gold gained modestly (slight beat of Silver) and Oil slid back to $101 and remains down on the week as Silver holds over 4% gains.
On Monday we saw stocks and credit in very good sync through the European session outperform and then decouple (green box 1) during the afternoon US session). Tuesday and Wednesday have seen a similarly well-synced equity-credit relationship through the European close but post-Europe very different. As far as boxes 2 and 3, we suspect that the HY (high yield credit) index is being held during European hours by relative-value trades against European indices and once that is closed, index arbitrage is playing a heavy hand (as the index was trading significantly cheap/wide to its underlying portfolio's fair-value. The compression between HYG (high-yield bond ETF) and HY remains a driver of the divergence between the two high-yield indices (but has largely been closed now) as HYG's NAV premium has also dropped. While headlines will look at this performance as indicative of risk-on, it feels very scrambly to us and furthermore has plenty of technicals (flow) impacting it also - HYG seems more 'real' for now (no matter how much it is over-bidding for junk-that-dealers-don't-want).
Whether it is rotation/rebalancing of implicitly underweight positions in index-tracking funds, a short-squeeze, arbs against CDS markets, or good-old fashioned momo-cashing, the major financials (most notably BofA and Citi - though MS and GS have also impressed) have torn out of the gate this year. Noone really knows which or all of the above though the mortgage refi rumors and now chatter over 'what do they know' about Greek PSIs is being discussed. The only thing we can add to this incredible move is that CDS (which have rallied with stocks the last week or two), stalled this afternoon.
Volume was up today as was average trade size (lower pane of the chart above is average trade size of ES for today - that is not total volume) - dramatically so. The second biggest average trade size in ES in five months suggests a topping process (or at least has done many times before) and timing seems 'appropriate' heading into tomorrow's auctions.
VIX opened up and stayed up - not budging much as stocks rallied in the afternoon - sustaining the divergence between index and underlying demand for protection that we discussed last week.
While short-term correlations saw broad risk markets underperform stocks impressive afternoon strength (and as we noted above stocks also outperformed versus the basket of 'high yield bonds and interest rates and VIX'), opn a medium-term basis CONTEXT (the broad risk asset proxy) saw convergence of stocks UP to its relatively stable level. For now, AUDJPY, negatively correlated 2s10s30s, and to some extent Gold (more risk-on correlated in the short-term) have been the biggest drivers (and it appears TSY/2s10s30s is flip-flopping from positve to negatively correlated as days go by and from morning to afternoon).
As an aside, from the 12/30/11 close, Gold is up 4.95%, the S&P 500 is up 2.77%, and the Long Bond is -0.65%.
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