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Pricing in a Recession, Liquidity Crunch, Or...

Tyler Durden's picture




 

From Peter Tchir of TF Market Advisors

Pricing in a Recession, Liquidity Crunch, Or...

The key macro driver this week has been the plan to plan a “Grand Plan”.  While the market has been focused on this big headline grabbing news, something is happening in the High Yield market that is worth watching.  The bottom end of the market is falling apart and this is during a period of retail inflows.

High Yield – Retail Buying, Professional Selling

HYG has been selling off this week.  It is down 1% since last Friday.  In the meantime, the S&P is up about 2%.  So it is interesting that High Yield has underperformed by 3%.  5 year treasuries are barely down on the week, so it can’t be rates, and the high yield market doesn’t track rates that closely anyways.

My first reaction was that there must be some pretty significant outflows.   But that is just not the case.  HYG and JNK both had increases in shares outstanding.  EPFR fund flows were positive $423 million this past week.  This strikes me as very odd.  High Yield price action usually tracks fund flows pretty well.

The above graph, while not great, shows that outflows typically accompany market sell-offs.  The move this week is highly unusual.  A big sell off in the market, but signs that retail is putting money into junk bonds.  That can only lead me to the conclusion that institutions and banks are pulling back from the market.  They are either worried about the potential for a recession or need to raise cash, or both.  The same thing is occurring in the investment grade space where LQD is declining, spreads are widening, yet shares outstanding increased.  This reminds me of the fall of 2007 when dealers were shedding all inventory because they were afraid of any risk and they were having funding issues.  In investment grade, the basis went from pick 15 to pick 35.  Some thought it was  great opportunity to buy bonds and buy CDS.  It turned out the funding pressure was persistent and that basis continued to get wider, peaking at over 100 after Lehman a year later.  There isn’t the exact same feeling as 2007, but this divergence between what retail is doing and what institutions seem to be doing needs to be watched very carefully.  It may not be as exciting as “Grand Plans” but in the end it may be more important and a better indicator of stress in the US financial system.

The CDX Index is trading cheap, but the ETF’s are trading rich to an already overstated NAV

There is another bizarre thing going on in the markets.  HY17, the CDX index is trading over 1 point cheap to fair value.  That implies that institutions are eager to hedge their exposure.  They are shorting something more than a point below where it should be trading in theory.  That isn’t very uncommon, but is a reliable indicator that liquidity in the cash market is non-existent.   What is particularly strange is that HYG is trading above its NAV.  So retail investors are willing to pay more for HYG than it is worth, and the NAV is probably overstated as there is always a lag during market sell-offs.  Either the professionals or the amateurs are wrong here.  Since retail investors tend to invest solely on the theory that the yield is good, I suspect they will be the ones to lose here.  They are overpaying to invest in an asset class that the real market is paying a penalty to exit.

The weakest credits are getting hit the hardest

The equity market may be debating whether or not the economy is headed for a recession, but the high yield market seems to have decided it is better to be prudent and is shedding risk.  These returns from the Merrill Lynch High Yield index show that the CCC component is getting hit the worst.

ML Index Component       This Week’s Return

BB                                   -0.77%
B                                     -0.88%
CCC and below                 -1.87%
 
The subcomponent returns are a clear sign that de-risking is occurring.  This makes me particularly concerned about what the ETF’s own.  There is a negative selection bias that as dealers “create” new shares, they deliver portfolios of bonds.  Retail is busy buying ETF’s and dealers are getting jammed on bonds.  You have to assume that dealers are delivering portfolios of the hardest to sell bonds to the ETF’s.  These are the bonds that are quoted and marked the furthest from actual clearing level prices.  This could be a big problem for the ETF’s.

Even the ML index understates how bad the performance of CCC bonds has been.  The index typically uses a mid market price for its calculations and will often rely on quotations rather than actual transactions.  As bid/offer spreads increase, the “mid” market price is further away from true clearing levels.  The quotations also tend to be on the high side as the dealers aren’t really making live bids, but would be happy to get lifted as they now they can find sellers of bonds if they can find a buyer willing to pay yesterday’s price.  This could easily overstate the market for “index” and “NAV” purposes by several points.  I pulled up 3 most active HY bonds according to TRACE yesterday.  The HCA recent new issue, which I wrote about yesterday, did reasonably well compared to the marked, but pretty poorly for a new issue where the dealers should have a nice short covering bid.  The other two bonds show the depth of the problem in the high yield cash market, a problem that has been largely ignored.

The “blue” bond is First Data corp 10.55% rated  Caa1/B-.  The “white” bond is Hovnanian 10.625% B2/CCC.  The round lot closing price for HOV was actually 79, so not quite as bad as the small trade that occurred at 77.5, but stil pretty bad performance.  Although the housing data yesterday was enough to let the HOV stock trade up marginally, the bond market did not care.  For a company with a market cap of only $150 million, I would pay more attention to what bond investors are saying about the prospects, than the equity market.

The high yield bond market is in worse shape than most people realize.  HYG looks extremely rich relative to what is going on beneath the surface, and this liquidation is occurring into quarter end, when bond investors have just as much incentive to “window dress” as stock investors do.  And it isn’t just domestic high yield.  Emerging Markets, and Asian Property companies in particular, are seeing their bonds getting crushed.  It may be more fun to watch the EU contort itself and find some way to lend money to itself that makes the markets happy, but in the depths of the credit world, there is a problem, and it is getting worse.

 

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Fri, 09/30/2011 - 08:27 | 1725314 snowball777
snowball777's picture

Freight trains don't start out very fast, but once they get going...

Fri, 09/30/2011 - 08:28 | 1725320 Josh Randall
Josh Randall's picture

This Baked Alaska is about to get  a blowtorch put to it

Fri, 09/30/2011 - 08:36 | 1725340 GeneMarchbanks
GeneMarchbanks's picture

Credit event for $1000 please Alex. "Why that's the DAILY DOUBLE!"

Fri, 09/30/2011 - 08:37 | 1725343 SheepDog-One
SheepDog-One's picture

I conclude Bernank's 'Grand Plan' involves a giant jar of Vaseline.

Fri, 09/30/2011 - 09:12 | 1725462 MFL8240
MFL8240's picture

And Barney Franks

Fri, 09/30/2011 - 13:02 | 1726371 nyse
nyse's picture

Yeah, right... He's like, "Fuk that; I'm going in dry."

Fri, 09/30/2011 - 08:40 | 1725351 buzzsaw99
buzzsaw99's picture

the bernank will buy them.

Fri, 09/30/2011 - 09:04 | 1725423 fuu
fuu's picture

They call him cumulonimbus because you know he makes it rain.

Fri, 09/30/2011 - 08:40 | 1725352 Village Smithy
Village Smithy's picture

Nicely done Mr. Tchir!

Fri, 09/30/2011 - 08:43 | 1725356 LawsofPhysics
LawsofPhysics's picture

Just so I understand this, the article is saying that the retail investor is betting on a weak rally, while the professionals are positioning for a sell-off.  Well duh, that is why they are professionals.  Did I miss anything?

Fri, 09/30/2011 - 08:43 | 1725359 lolmao500
lolmao500's picture

October 24, something big will happen that will cause a collapse in the markets.

Fri, 09/30/2011 - 09:18 | 1725475 DeadFred
DeadFred's picture

Dang, options expire the 21st!

Fri, 09/30/2011 - 13:03 | 1726381 nyse
nyse's picture

Pole shift? Mayan calendar running out? Santa Clause suicide? WHAT IS IT???!!!

Fri, 09/30/2011 - 08:52 | 1725381 fdisk
fdisk's picture

Why even talk about US bond Market? It's controlled and manipulated
by the FED. It showing what the FED does and nothing else.

Fri, 09/30/2011 - 08:59 | 1725384 CrashisOptimistic
CrashisOptimistic's picture

This is not bad analysis, but lacks a bit of depth.

HYG and JNK are traded vehicles.  They are not lockstep with their index.

Managed funds like FHIFX and PRHYX have such extensive holdings that they capture the variance of the universe of all HY bonds.  In other words, they are likely as good as an index themselves, even as the managers maneuver the portfolio.  When sample size of a universe is large, it's difficult not to be a representative sample.

Point being, FHIFX is still up YTD.  The S&P is down 7%.  The enormous monthly payout by HY conceals a lot.

I'd also suggest a retail vs professional perspective for the HY space is pretty shaky.  Not a lot of retail trading in that space.  Retail pursuit of an asset allocation niche would be via HYG or a managed fund, not individual trades.

 

Fri, 09/30/2011 - 09:03 | 1725416 oogs66
oogs66's picture

4% of that portfolio is Icahn Enterprises.  Biggest holding is AMD.  Both decent companies - by high yield standards.  That manager has done a good job positioning for the problems by owning higher quality credits.  HYG and JNK will own the worst of the worst and do tend to search for big coupons at expense of safety.

I think retail is HYG - doing okay.  Bonds are professional - trading worse than even reflected by the indices.

Fri, 09/30/2011 - 09:04 | 1725425 CrashisOptimistic
CrashisOptimistic's picture

True, but the AMD issue got smacked this week and FHIFX is still up.  PRHYX is outperforming the S&P, too.

That monthly payout is powerful stuff.

Fri, 09/30/2011 - 09:08 | 1725444 CrashisOptimistic
CrashisOptimistic's picture

Another point is "safety".  Safety in the HY space is measured by default %, and it simply is not high.  Recession could raise it, but overall it's just not high.  Companies have too much cash on the balance sheets borrowed at very low rates to actually fold.

And that cash has to pay interest before anything else.

Fri, 09/30/2011 - 09:51 | 1725588 oogs66
oogs66's picture

the move in ccc credits seems to indicate that default risk is growing

Fri, 09/30/2011 - 08:55 | 1725388 Robslob
Robslob's picture

 

 

 

Speaking of "junk vehicles" my I interest you in some stocks today?

Fri, 09/30/2011 - 09:01 | 1725406 fdisk
fdisk's picture

Interesting to see how you guys thinking on Hourly basis. Like, if he was in the Market 2 days ago when Market was up 300 points? Then it's ok, I guess. Today DOW down 120 and no good to be in the stocks Who are you? 5min scalper? People buying stocks for 5-10 years outlook, usually. Who f*cking cares about 1 or 3 hours from now.

Fri, 09/30/2011 - 09:02 | 1725418 CrashisOptimistic
CrashisOptimistic's picture

Perhaps someone who doubts there will be a stock market in 5-10 years.

Fri, 09/30/2011 - 09:07 | 1725439 fdisk
fdisk's picture

And what you think? Stone age, cave man?

Or your Silver/Gold junk will make you a KING in woods?

I can guarantee you there always going to be a Stock Market,

perhaps not for people like you.

Fri, 09/30/2011 - 09:14 | 1725469 MFL8240
MFL8240's picture

Probably so for the shorts but upward momentum, not gonna happen didnt happen in the 30's either.

Fri, 09/30/2011 - 10:46 | 1725760 Quinvarius
Quinvarius's picture

Why are paper money junkies always so bitter?  Of course real money makes you rich and paper money always dies.  You guys act like every little intervention in the metals markets is some big crash.  Gold will continue to rise until it backs the money supply.  It is the law of the markets.

Fri, 09/30/2011 - 09:07 | 1725435 Henry Chinaski
Henry Chinaski's picture

End of September.  Quarterly and FY close out.  Next week could be ugly. 

Fri, 09/30/2011 - 09:09 | 1725445 fdisk
fdisk's picture

Or could be good, that's why there is a Market.

I think Market will break to the Upside finally, simply because

90% of the people thinking otherwise.

Fri, 09/30/2011 - 09:23 | 1725495 Henry Chinaski
Henry Chinaski's picture

Yes. That is a possibility also and your reasoning is good.  I stopped trading stocks while back and don't plan to get back in the market any time soon.  If I want to gamble, I prefer a good casino where pretty girls bring me free drinks and it is commonly understood that the house always wins in the long run.

Fri, 09/30/2011 - 11:26 | 1725901 slewie the pi-rat
slewie the pi-rat's picture

yep!  H_China_ski!

you think like slewie, you poor bastard! 

and, yes, according to the meanderings of large numbers, the house always "wins" but those pretty girls, dealers, pit bosses, floor managers, players' reps, bus bonuses, slot machines, electricity, taxes, techs, free dirinks & comps, security, surveillance, cashiers, cooks & bartenders, entertainment, drawings, valets, and back office & custodial staff aren't free! and they gotta pay their lenders, too, b4 "profits for equity"

besides, you get a "fair game":  something even the swiss have now abandoned in "the markets"!!!  now, it may be the modern equivalent of faro in dodge under the earp brothers, but winners seek a + EV anywhere they can, even in divergency from the norm of the random # (or event) generators, and the implied risk/reward in soaring slot bonuses

besides, the "wall street casino" has quite a bit of "overhead" too, doesn't it?  not to mention the "overhang"  which is a wonderful mcchesney martinism, isn't it?  maybe from tee many martoonies at the fuking "punchbowl"...? 

Fri, 09/30/2011 - 09:48 | 1725576 Ricky Bobby
Ricky Bobby's picture

Market? Where is that. I see intervention, manipulation, corruption and lies, so where is this market you speak of?

Fri, 09/30/2011 - 09:24 | 1725497 ISEEIT
ISEEIT's picture

For all of the wrong reasons, you might be right. Here in the rabbithole up is down and left is right and so might you be.

Fri, 09/30/2011 - 10:29 | 1725682 disabledvet
disabledvet's picture

we really need to move beyond "risk" and whatever the hell "de-risking" is. All that's happening (which in the Age of Information is "a good") is that "risk is getting priced." It seems to me when treasuries soar in value "the price of riskiness" may rise in the sense that "money is in the debt not the equity" but this isn't the same as what happens when a debt market collapses ala Greece. (Can risk even be priced over there?) It need not mean Armageddon but it certainly can be a symptom of it. To be clear however "the market is not waiting for the outcome of the Normandy Invasion" here. What we might be waiting for is something that hasn't happened (a break up of the EU for example.) Should we PRICE that in? Is this PRICED in already? There is always risk---and equites "refuse to collapse" because i imagine ultimately "the price" is not the Sum of All Fears but something "we" are working through. I happen to agree with the latter and am not surprised that the market keeps catching a bid. On the other side of course are "the window dressers" apparently. Who knew "window dressing" was such a terrible behavioral trait? I'll have to get the bino's out to see "what they're really up to over there."

Fri, 09/30/2011 - 10:25 | 1725684 ivars
ivars's picture

Here is comparison chart between my feb 6th chart of DJIA and actual prices. After 8 months with mistakes in the middle, its for last 2 months within 0-5% of actual DJIA:

 

http://saposjoint.net/Forum/viewtopic.php?f=14&t=2860#p34298

 

In original chart, the trend continues to go down with increasing speed.

Fri, 09/30/2011 - 10:30 | 1725698 Stuck on Zero
Stuck on Zero's picture

Everyone I know who has any cash is jumping in to property.  They get zero interest in the bank yielding -10% after tax and inflation.  They can get a solid few percent in a rental property and hope to get some appreciation some day. 

Fri, 09/30/2011 - 10:49 | 1725769 Quinvarius
Quinvarius's picture

Too early.

Fri, 09/30/2011 - 10:50 | 1725740 virgilcaine
virgilcaine's picture

Credit is pricing in Armageddon.  Equites are just waking up with a six month lag and big declines on the way.

AAA Corp Bond yld @ 4% today means the S&P is overvalued by around 50%!

Fri, 09/30/2011 - 11:27 | 1725765 slewie the pi-rat
slewie the pi-rat's picture

"pros" just shorting the etf's maybe?

when liquidity is a 'problem', what a freaking "solution" that can be for the junksterz! 

eh?

Fri, 09/30/2011 - 10:52 | 1725786 Quinvarius
Quinvarius's picture

What we are seeing is the paper money crash being expressed via fixed income and slightly masked by the Fed buying Treasuries.  If Treasuries matched other credit declines, you would have no doubt that was the case.

Fri, 09/30/2011 - 10:56 | 1725798 virgilcaine
virgilcaine's picture

Tyler may I be so bold to say that the S&P trading at 600 .. is within the realm of possibility in 2012.

Fri, 09/30/2011 - 11:03 | 1725820 virgilcaine
virgilcaine's picture

Quinvarius the credit markets are much deeper than that I respectfully submit.

Fri, 09/30/2011 - 11:46 | 1725861 winningfastball
winningfastball's picture

I'm seeing this retail buying everyday with my own eyes.  My discretionary retail PM's have been hesitant to deploy cash in bonds for the past 18 mos.- 24 mos. and now with equites plummeting off the side of a cliff they are starting to look for other opportunites and many are moving into the HY space.... thanks to the -ve real rates on gov't/ Prove/Muni/bonds and the management fee ontop,  the pressure invest to find "Yield" in what is preceived to be "Moderate" Risk relative to equities is starting to get to my guys.  Although yields seem attractive on some equites their clients have been scared to the 'safe haven" of bonds and by default forcing my guys into the HY space to appease(keep) cleints.... Mjr. Payne ahead

Fri, 09/30/2011 - 12:37 | 1726248 msmith
msmith's picture

The currency markets are definitely a key driver for equities, especially EURUSD.  It appears the EURUSD may rebound in the very short term, but the pair has much further to drop. Here is an interesting analysis of the EURUSD http://bit.ly/pCtQ88.

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