Volume Crashes As Stocks End Unchanged
Amid the lowest NYSE volume of the year (-24% from Friday - OPEX) and pretty much the lowest non-holiday-period volume in 9 years based on Bloomberg's NYSEVOL data, ES (the e-mini S&P 500 futures contract) ended the day almost perfectly unchanged underperforming 5Y investment grade and high-yield credit indices on the day as both moved to contract tights (their best levels since early August last year) even as their curves flattened. There has been lots of chatter about how the steepening of the short-end of the European sovereign bond markets (Italian 2s10s for instance) is a sign that all-is-well in the world again, well unfortunately the flattening of the short-end of US IG and HY credit markets sends a rather less positive signal than headlines might care to admit (as jump risk in the short-term remains 'high' relative to bullish momentum in the medium-term). At the same time, vol markets are showing extreme levels of short-term complacency as 1m VIX is almost at record low levels relative to 3m VIX (and diverging today from implied correlation). Broadly speaking , risk assets rallied into the US day session open only to sell off into the European close (with Sovereigns leaking back the most). The afternoon saw risk rallying as the path of least resistance appears to be up all the time there is no news. Stocks ended well off their highs of the day, in line with broad risk assets, as TSY yields rose 3-4bps higher, Oil and Copper 1.5-1.75% higher (outperformed) while Silver and Gold hugged USD weakness at around a 0.5% gain from Friday's close.
With a third of the quarter already done, this is shaping up to be an even worse quarter for banks that Q4. With trading volumes so far this year 18% lower than the Q4 (ex-Xmas), we can only assume that what they lose in volume they make up for in margin so expect your bid-offer spreads to widen (viciously exaggerating the decline in trading volume we suspect). The chart above shows the mind-blowingly bad NYSE stock volume appears to be the lowest non-holiday period trading volume we have seen in 9 years (or the data that we have from Bloomberg).
After tracking closely for the last few days, ES limped off into the close today as IG (investment grade) and HY (high yield) credit rallied on to close at five-month tights. HYG (the high yield bond ETF) gave some back at the close. ES downward reversion at the close pulled it to close at its VWAP suggesting very little aggressive positioning today though volume was heaviest as we sold off (from 10ET to 12ET) after which (the EU close) we leaked higher.
Under the surface, the bullish moves in credit spreads (which are undoubtedly positive) have the IG (above) and HY (below) credit indices trading at multi-month 'flat' levels. Typically we would expect a credit rally to be led by the front-end as default risk (liquidity-aided) dries up and we see jump risk removed from the market (also these shorter-dated maturities have lower durations and some risk control - though technicals can make them less liquid). In this rally we have seen the curve flatten (a more bearish move) suggesting that the exuberance that 5Y spreads have enjoyed (purple), both now trading extremely rich (tight) to where their underlying portfolio would suggest is fair (lower pane shows just how rich IG and HY are in 5Y and not in 3Y), is yet another reflection of complacency.
The skews will help understand: 5Y HY is 34bps rich (expensive to its portfolio's value) while 3Y HY is about 10bps cheap (wide) and in IG it was even more interesting with 5Y around 11bps rich ( a huge difference at around 10% of the index - equivalent to the S&P 500 trading at 1400 while the underlying stocks of the S&P 500 imply a fair-value of only 1260) while the 3Y IG is trading 4bps cheap (wide) of its fair-value.
The point is that understanding what is going on across the credit curve and indices relative to their underlying value suggests that professionals are positioning far less bullishly than 'opticals' would suggest (just as we noted last week in equity options skews, implied skewness, and kurtosis) and also below in volatility term structure steepness.
The chart shows the steepness of 1m implied vol over 3m implied vol. The lower the chart, the steeper the term structure and the more complacent short-dated volatility becomes relative to medium-term vol. The option expiration on Friday has an impact but we see almost record levels of relative complacency in short-term options vs medium-term. We find it fascinating that Goldman publishes a paper to push buy-write strategies at the same time as short-term vol is so low (if we were a suspicious, we would guess that GS got loaded with hedgies selling vol - covered calls - and were looking to unload some of that exposure to others). Of course, we could also be seeing event risk hedging across the Greek bond maturities in March by selling short-term vol to pay for vol that is the other side of this huge event.
FX markets were typically more active during the European day session and were relatively calm as Europeans and Asians left the market. EURUSD held above 1.30, Cable underperformed (the only major weaker against the USD) as JPY was very quiet. GBP and JPY's underperformance helped DXY outperform EUR for a change as the USD proxy only lost 0.5% from Friday.
Commodities separate this afternoon into 'fiat-related' and 'economic' as it were with Gold and Silver outperforming in line with USD's weakness (after some early exuberance in Silver) while Copper and Oil stayed together and outperformed as the latter toyed with $100 once again.