CDS

CDS

The Credit/Equity Disconnect Is Now Complete: All Financial CDS Are Wider

No one needs to look at stocks to know how JPM, and the other TBTFs are doing. After all they are now firmly in the clutches of the HFT/Citadel/FRBNY pump machine. Yet a glance elsewhere confirms that all correlations between stocks and credit are terminally broken. To wit, note the following CDS spreads as of moments ago:

  • JPM 85/88 (+4)
  • MER 184/189 (+6)
  • MS 170/175 (+5)
  • WFC 105/110 (+6)

Be careful trading financial stocks: JPM's earnings were actually very bad, and so far only credit has figured it out. Equities, being traded now exclusively by Fed-frontrunning retards and virus-infested robots, are a little slow.

How Mispriced Equity vs CDS Tail Risk Allowed A 158% Annualized Return In BP

One look at the huge crowd at today's fantastic SocGen Tail Risk Hedging conference should confirm all fears that the bulk of speculative investors couldn't care less about riding the levered beta market, and instead everyone is focused precisely on the conference topic: how to isolate and hedge for tail risk (in addition to idiosyncratic, market, correlation and macro). While we will share quite a few of the thoughts by such prominent thinkers as Dylan Grice and Stephen Antczak, we wanted to highlight one trade which caught our attention: namely the mispricing of tail risk as represented by equity and credit derivatives in BP at the time when the company's bankruptcy seemed like a sure thing. Due to a major skew resulting from a huge imbalance in implied vol, a perfectly hedged trade which saw the selling of equity vol through near terms puts, coupled with the purchase of default protection via 6 month CDS, would have yielded a 158% annualized return at trade unwind 3 months later. In other words, which it is difficult to generalize, it appears that in times of dramatic risk, equity derivatives tend to overprice fat tail risk, while default protection is underpriced. Such capital structure arbitrage trades will become increasingly more profitable as the Fed-created drift between equity and credit accelerates, and as vol pricing allows phenomenal arbitrage opportunities.

On Jumping Sharks With Barry Ritholtz

Barry Ritholtz is once again in Zero Hedge-marketing mode, which is probably not too surprising: this marks only the second time in under a week in which Mr. Ritholtz has exhibited a fascination with Zero Hedge, previously demonstrating a borderline obsession by actually scouring through tweet mentions of our humble blog. And humble we are - we have paid Barry exactly zero for this ongoing free advertising fest. That said, we are confident Barry will be happy with us reposting his entire post for our readers because he does bring up some valid questions, to which we provide our own brief perspective.

John Paulson Lecture: "Bonds Are Wrong, Stocks Are Right"

John Paulson is now 'all in' that for the first time in history bonds are wrong and stocks are right... We'll take the other side of that bet. Of course, this also means that David Tepper is across the table as well. Oh well, we do like to live dangerously. Full notes from Paulson's lecture at the University Club, to a standing audience. Then again, if anyone suspected that JP was actually on the same side of the bet as us, it wouldn't really work now, would it...

Guest Post: The Shoeshine Boy

Why the price of (paper) gold may well plummet, as physical gold prepares to approach its true value in the $50K+ range (if at all quantifiable using current currency), as explained using e-mails, Nash Equilibria, condoms, and other parables, by FOFOA

Reggie Middleton's picture

You know times are bad in the housing industry when home builders hang up the hard hat and take to running leveraged hedge funds. Hell, they don't even have to be any good at it, because they are using 0%, non-recourse loans with very little of their own capital (bubble style leverage), thanks to YOU, Mr. and Mrs. Taxpayer bitching about unemployment and higher taxes. I hope this doesn't piss anybody off,,, again!

Why Massive Offshore Cash Parking Means Companies Have Access To Only A Fraction Of The Record Cash Stash

Yesterday's Microsoft issuance of $4.75 billion in new debt, of which the 3 Year maturity portion priced at the lowest yield ever for a corporate bond of 0.875%, came at the pristine, and much discredited AAA rating. Yet what this little experiment revealed, in addition to confirming that the corporate bond bubble has never been greater, is that the cash on the sidelines argument used by every single permabull on CNBC is sorely lacking in some factual details. Namely, that a dollar at home is worth more than a dollar abroad, as BofA's Hans Mikkelsen puts it succinctly. Let's back up for a second: the primary reason why investors are funneling their capital in droves in tech and other companies that have key foreign operations is precisely due to the fact that while their domestic subsidiaries may be expiring, it is the foreign subs that are generating the bulk of the revenue, profit and thus, cash. Yet what very few have considered, is that repatriating his cash to the good old USA would cost companies hundreds of billions in US corporate taxes. That's right: even though companies are taxed abroad, the issue of double taxation is resolved by subtracting foreign taxes paid from the US tax liability. However, because foreign corporate taxes are typically lower there is an adverse tax consequence associated with remittance to the parent company. In other words, of the $1.2 or however many trillions in total corporate cash on balance sheets, a good 30% chunk of this belongs to Uncle Sam if these companies wish to use it for domestic IRR purposes. And yes, just so there is no confusion: using foreign cash to pay dividends or share repurchases is considered repatriation from the perspective of US tax regulations. Enter Microsoft: most of its cash resides abroad and is essentially useless for dividend purposes, unless the company wishes to see its net cash position cut substantially upon repatriation. Yet with everyone now clamoring for increased dividends and stock buybacks, the company is forced to access domestic capital markets and use that money for shareholder friendly activities. This is a capital mismatch fiasco just waiting to happen. The only possible winner out of this - Uncle Sam, who may soon order foreign cash to be repatriated over corporate pleas otherwise.

Irish Bond Auction Completed Courtesy Of ECB Backstops, As Europe Now Lives Paycheck To Paycheck And Auction To Auction

Today's market ripping false strawman (as if the ECB would let the Irish bond auction fail) was the issuance of €1.5 billion in 3.5 and 8 year bonds out of Dublin. And with yields a full percentage point higher than before, ECB backstopped banks using the newly purchased Irish bonds as collateral with the ECB, and/or the ECB picking up who knows how much itself, today's auction was a smashing success, if one can calls paying 6% for 8 year bonds success. But the market apparently loves ECB interventions so much it has tightened Irish CDS by 15 points on the day. Full results are as follows.

Reggie Middleton's picture

Any readers who read the back and forth between Tyler and TRS should ask themselves, "But why didn't the Fund answer these important questions?". Hey, they may not be in a death spiral, but when you make what looks like desperate moves and your returns are spiraling at the same time your liabilities are soaring, all the while your risk is flying through the roof... One should expect a blogger or two to take notice, particularly those bloggers who can count.

Illinois' Pension Fund Death Spiral Revisited: "10 Years Of Money Left"

A month ago, we discussed the death spiral that the Illinois Teachers Retirement Fund has now entered by openly commencing to sell its securities. We stated: "At this point it is too late: for TRS, and likely for many, many
other comparable pension funds, which had hoped that the Fed would by
now inflate the economy, and fix their massively incorrect investment
exposure, the jig may be up. As liquidations have already commenced, the
fund is beyond the point where it can "extend and pretend", and absent
the market staging a dramatic rally, government bonds plunging, and risk
spreads on CDS collapsing, the fund is likely doomed to a slow at
first, then ever faster death
." This speculation immediately prompted a response by Dave Urbanek who replied to Leo Kolivakis (we have yet to hear from Mr. Urbanek directly), who said: "Please remove your post of Tyler Durden’s inaccurate analysis of the Illinois Teachers’ Retirement System. It is not excellent. It is wrong. TRS is not in a death spiral. We’ll still be operating and paying pensions for years to come." Yup - about 10 years to be precise, and then it's over. Today, Bloomberg's Jon Erlichman settles the debate, by focusing on the Illinois State Board of Investment in a special video report, where he confirms that absent state funding "the $9.6 billion fund, in less than 10 years, could have no money left. If they get no state funding and they just have to rely on employee contributions, there you go, you could go from $10 billion to zero in less than ten years." There you go indeed. Our condolences to Illinois pensioners - you now have about 10 years of natural asset coverage, absent your pension funds becoming the latest government-sponsored ponzi scheme.

Guest Post: The Foreign Exchange Market And CDS Spreads

We are continually amazed at movements in the foreign exchange market that come as a direct consequence of moves in peripheral 5-Year Credit Default Swaps (CDS). The chart below details the relative correlation of a GDP weighted basket of the relevant countries within the Euro. The relationship makes sense. When spreads blow out they do so because investor anxiety over Europe's credit position increases, anxiety over credit worthiness in Europe sees investors selling EUR/USD. However lately moves in the smaller peripheral components have been resulting in out-sized moves in the EUR. Something strange is a-foot.