The middle of the week appeared to be the storm before the quiet of today before the potential storm of next week with aggressive action by the ECB this morning seeming to calm fears (and raise hopes of more) as risk assets were generally calmer today. Amid dismally low volumes, ES ended the day very marginally lower (led by Tech and Energy), commodities were mixed, IG credit outperformed TSYs and HY credit, and FX vacillated back to unchanged in general capping another week of strengthening USD vs the Majors (except JPY). US equities shrugged off a broad risk-off shift early in the day (driven by Oil and TSYs mainly) as OPEX seemed the focus of controlling intraday vol with CONTEXT and ES closing the week in almost perfect agreement (leaving cash S&P -3.3% YTD vs Gold +21.3% YTD).
Unlike yesterday's close, which was led by stocks and not sustained by broad risk assets, today's notable dive in ES was fully backed and supported by credit, commodity, FX carry, rates, and spreads. Volumes dried up as the afternoon progressed as we suspect machines were turned off on the vol regime shifts and real 'value-investing' money was patently absent - now Bill Miller has left the building. HYG underperformed and was first to move as we sold off just after lunch (on what we suspect was driven by the transparency of the USD funding difficulties we discussed). Liquidations, thanks to CME margin moves, did not help and dragged commodities hugely lower - even as the dollar (and EUR) ended almost unchanged from yesterday's afternoon close. The clarion call for the ECB's bazooka will be loud this evening.
The late day collapse in financials (thanks to Fitch's comments that seemed to wake up a sleeping equity market to the reality that credit has been screaming for weeks) helped drag equities (and HY debt) significantly lower. Most notably, amid a much higher than average volume day today, the dislocations of the last few days - that we have highlighted - have converged very rapidly this afternoon. ES significantly underperformed a broad basket of risk assets (CONTEXT) into the close as copper and oil gave back some of the day's gains. TSYs closed at low yields for the day - and 2s10s30s dropped significantly - as we warned it would have to sustain any sell-off as EURUSD tracked back towards its lowest levels of the day dragging DXY up to almost unchanged on the day (+1.7% on the week). On a longer-term basis, HY markets are priced for an S&P around 1190 currently but as HY also collapses wider, we will rapidly see the 'expected' S&P level drop further. Credit Anticipates and Equity Confirms is often cited by old-school credit market professionals - it seems once again that it is true. What is more evident, and discussed by Peter Tchir of TF MArket Advisors, is the morphing of the sovereign crisis into a banking system crisis as TPTB are unable to achieve anything of note.
David Tepper was not the only one cutting his exposure across the board: in Q3, Dan Loeb's total reported AUM dropped from $2.7 billion to $2.1 billion (granted this is not indicative of his actual portfolio holdings across funds, just what he reports to the SEC). The most notable change was the $632 million stake, or 48 million shares, he reported in Yahoo - a move which Zero Hedge disclosed first, although the full size of which was unknown. In addition to a $632 million equity stake, he also revealed at $26.7 million call equivalent to 15 million shares of stock. Aside from that the main story was one of derisking as he sold off his entire positions in BP, Cablevision, Freeport McMoRan, Freescale, Lyondell, NXP, Pall, ON Smi, Pall, Potash, Quest, Safeway, Swift, and Whirlpool. In addition to YHOO, he added a few other new positions, the most notable and largest of which is HollyFrontier: the same new position as was initiated by Tepper, as noted previously. Perhaps this one deserves a special focus as the hedge fund hotel appears to have spoken and to like it, and is largely under the radar. In addition, he also started new positions in Celanese, Agco, Expedia, FMC, Gardner, Gilead, Fragtech, Warnaco and some other small stub positions. But overall, the theme of the portfolio is one of broad portfolio reduction and deleveraging, coupled with going aggressively to cash.
Investment grade and high yield credit spread markets, which typically trade very closely coupled with equities, followed the path of the European session and completely negatively diverged from stocks today. IG and HY credit closed very close to its wides of the day while the S&P managed to limp up on average volume to close near the day's highs - after stagnating around VWAP for much of the afternoon. Into the close, we saw a similar pattern to yesterday as hedgers jumped in to credit and HYG (the high-yield ETF) dropped significantly and IG credit (a cheap hedge) lost ground. ES tracked risk markets (outside of credit) almost perfectly all day long - something we haven't seen in a few days - as today appeared very much a wait-and-see day with Europe's modest outperformance enough to quench sellers in equity positions for today at least. Commodities (ex-Oil) were largely unchanged as the dollar ended modestly lower as EURUSD oscillated on Merkel rumors and correlation trades. TSYs rallied off what was an awful 30Y auction but ended the day higher in yield and steeper in curve.
The last few weeks have seen numerous discussions of the less-than-perfect quarterly earnings picture and outlook and despite an endless barrage of 'well, 73% of firms beat expectations', it is the outlook that is critical to understanding valuations. With CEO Confidence, from Chief Executive magazine, at its lowest in a year and having dropped at its fastest rate since the first quarter of 2009, Goldman dissects the conference calls of Q3 earnings to discern four key themes: Uncertainty is hurting confidence and reducing activity, a more cautious tone on margins, and belief/hope in emerging markets' ability to power growth. Goldman's 'Beige Book' equivalent provides all the detail one needs to comprehend what is at best a defensive strategy going forward.
With the S&P closing -2.5% led by another financials sell-off (-4.3%), the long-hoped for late-day-rumor failed to appear and save the knife-catchers. The major credit indices modestly outperformed equities today although the after-hours (Greek govt is not collapsing) rally-monkey dragged ES (up to VWAP) closer to credit's performance as stocks closed back to 10/21 levels while credit held more in the 10/24 region. Another huge day in the TSY complex saw the 30Y rally around 15bps (back under 3%), 10Y drop back under 2% and major flattening continue as 2s10s30s collapses further. FX markets were dominated by EUR's referendum-on / referendum-off volatility as the dollar maintained its strength which was ignored by Gold which managed to rally while commodities and silver generally lost ground today. Implied Vol and correlation spiked as macro protection was bid in equity markets but notably, secondary bonds and CDS saw major regions of net-selling as opposed to blanket protection demand - suggesting IG credit has reached its limit on second-guessing and is derisking at the individual level (as opposed to macro hedging) especially higher beta names.
While much was made of the MF Global news today, we suspect that the tipping point for risk assets was more likely driven by the plethora of reality-based analysis of the situation in Europe combined with the afternoon news that Greece is facing a referendum and a lack of demand for the EFSF issue today. Heavy volume arrived into the close to the downside, suggesting asset allocation rotation from equities to bonds, which helped propel TSYs even further down in yield. The entire complex flattened notably with 30Y outperforming -24.5bps, the largest single-day yield move since March 2009, as the much-watched 2s10s30s butterfly has retraced all of last week's increase. ES closed at its lows (down over 2.5%) only to extend those losses in the evening session as we post as IG and HY credit tracked notably wider once again.
Financials were the day's worst performers as already-priced-in downgrades from Europe, and absolutely not-priced-in talk of worrying liquidity upsets in RMBS markets, staggered them -3.5% pulling back to very fractionally above unchanged on the week. S&P futures managed a small loss on the second lowest volume day since 9/20 with some 'inhuman-looking' moves especially towards the close where ES ripped 20pts (with no support from risk) only to give it all back even quicker. FX also traded in very gappy mode today with some rips and dips - especially after Europe closed as the USD ended the day higher but down marginally lower on the week. TSYs weakened into the close with 30Y outperforming (and 7Y underperforming) post NFP this morning. Credit remained stubbornly weak into the close even as equities burst higher which is similar to commodities and oils in the last few hours as they dropped from their earlier highs and stabilized.
You didn't think the Fed would let more than a few months pass without the much beloved and dearly missed near-daily POMOs now did you. The FRBNY's Brian Sacksters just released the October schedule of $44 billion in long-dated purchases, and $44 billion in short-dated sales. Since the net effect to banks is one of derisking, the offsetting rerisk will be implemented in the form of more stock purchases. Hopefully their prop desks (which no longer exist, right, after all the whole Volcker Rule thing and the UBS fiasco...) will know how to trade Netflix this time around better than last time.
As Goldman's David Kostin summarizes in his latest weekly kickstart chartology, the market continues to be a dueling story between slightly better micro (although certainly not in Europe) and deteriorating macro. "Two weeks ago the narrative of the market was the triumph of politics and profits. News from inside the Beltway suggested a deal to curtail spending and raise the federal debt ceiling was in sight and a steady sequence of very strong earnings reports led by the Information Technology sector combined to push the market higher. However, the news this week was decidedly less market-friendly....Our client discussions indicate investors are in full “risk-off” mode and they plan to continue that posture until sovereign uncertainty subsides. Lack of conviction regarding the outcome of politically-charged fiscal negotiations has compelled hedge funds to reduce risk by lowering gross exposure and mutual funds to stay close to benchmarks. Investors are refocusing on corporate balance sheet strength as a key factor in the stock selection process and we re-balanced our strong and weak balance sheet baskets. 331 stocks have released 2Q earnings and the results have been strong although several firms slashed 2H guidance during the past week." And as a reminder, the bulk of the upside has come from one company alone: Apple. Also, it is gradually getting uglier on the earnings front: "During the past week a number of firms reduced EPS guidance for 2H. Examples include ITW, JNPR, MUR, and SO. Several firms specifically commented that business activity slowed sharply in June and July." And with a slew of financials reporting shortly, next week is sure to tip investor sentiment further into derisking mode.
Stocks outperformed credit at the index level today but there was a significant shift in internals in corporate credit that provides the context for continued weakness in risk assets.
The rise in systemic risk in HY credit markets has spread to equity and IG credit markets respectively as we forecast but we see a number of other indications that are very troubling. Financial systemic risk is up 23% in two months and at eleven month highs (aside from brief spike in Jan).
Credit markets are sending some worrying signals for risk appetites. Systemically rising spreads in HY, among other charts we highlight, suggest fixed income players are getting the post QE2 joke ahead of stocks.
Equities have significantly underperformed credit the last two days but have plenty of room to go before they re-sync with any kind of value. Rotation under the surface points a risk-averse crowd seeking safety and not poised to BTFD.