Capital Context Update: Dispersion Rising

The same themes remain in place (equity to credit preference, up-in-quality credit, and rising dispersion or idiosyncratic risk), all of which warrant concern over equity levels. While earnings are supposedly the mother’s milk of stock prices (someone really smart told me that every day this year?), we are reminded that free cash flow is the real driver and profits are a levered result of GDP growth which is being downgraded lemming-like as we speak. While credit availability remains good for IG issuers, the potential for relevering (shareholder-friendliness) may be tainted if US CEOs continue to behave like Japanese CEO did in the 80s/90s – expecting lower than trend growth they hoarded and burned through cash. We like IG-HY decompression, HY 3s5s flatteners, Financials underperforming non-financials, and would remain fully hedged in The A-List for now. Our ETF Arb is stable and has more room for upside.

Capital Context Update: Natural Normalization

Contextually, today was interesting bottom-up with only 53% of names agreeing in terms of direction for credit and equity risk (dominated by 50% agreement that conditions deteriorated). 27% saw credit widen as equity rallied while 20% saw credit compress as equities sold off but at the sector level the picture was much more stable with most agreeing systemically worse today. Leisure, healthcare, and Consumer Cyclicals were the only divergent sectors with credit underperformance as equity managed gains (only just in the latter we note). While we saw a clear up-in-quality shift in single-name credit today ( a theme we have been suggesting recently), that was not the story in equities where higher quality names (BBB and above) actually underperformed on average those in the spec grade cohorts. Vol movements were in line with CDS once again with vol rising less for the better quality names and rising dramatically more for the lower quality names (with a particular emphasis on the crossover names in fact).

Lipper Reports Largest Ever Weekly High Yield Outflow

Just out per Lipper, High Yield recorded its largest weekly outflow ever with a negative $2.8 billion this week. Presumably this is due to the risk off mood in the markets carried over from last week, or maybe just more funds converting out of fixed income and pumping into equities in advance of what even the futures just seem to realize is an inevitability (go ahead, check out the ES chart AH, we dare you). That said, per ICI there was a 3rd consecutive outflow from domestic equity, so perhaps this was simply derisking. Continuing on the Lipper news, the 4 week average dropped from $181 million of inflows to $641 million in outflows, pushing the year to date down by half to just $2.9 billion in inflows. On the other hand, loan funds continues being John Holmes with $9.5 billion in YTD inflows, although just $57 million (down from $686 million) in the last week.

Gold/Copper Ratio Surges By Most Since June 29

As Credit Suisse points out, today the Gold/Copper ratio is up by over 4% to 3.32, which happens to be the biggest one day move since June 29, and confirms that not only the copper run may be over, but that derisking and the flight to safety trade is truly back on. Although one hardly needed to see this chart to come to that conclusion: even as the market continues to expect an announcement from Bernanke that CTRL-P Central (f/k/a the Marriner Eccles building) will start printing crude any minute, the wait may end up being quite protracted. And while gold has not been touched yet, and in fact continues to trade at all time highs, we wish to repeat our warning that should the crunch in the S&P continue (even if it is modest by historic amounts), it is very likely we may see liquidations in HF precious metals holdings considering the HF margin debt position is at virtually all time highs, meaning the toxic spiral of plunging prices and broad deleveraging in advance of margin calls, will lead to a sell off in anything and everything that is not nailed down.

Vega Strategies: Loan Request To Ben Shalom Bernanke: Divide One Upcoming Day's Worth of Asset Purchases Between Wall Street and American Entrepreneurs

Ben Shalom Bernanke, we the entrepreneurs of the United States of America request that you divide one upcoming day's worth of asset purchases between Wall Street and us, to wit, may the tiny sum of $3 billion, minuscule juxtaposed with the hundreds and hundreds of billions of dollars you are feeding your Primary Dealers and their clients in your Quantitative Easing program, may the modest sum of $3 billion be used for a pilot program to purchase securities issued by American entrepreneurs in connection with the startup of 3,000 validly formatted new business enterprises, such $3 billion to be used to purchase $1 million of the Perpetual Subordinated Capital Securities of each. Your pilot program, Ben Shalom, will show results almost immediately, thereupon you should expand the program, first to $5 billion, a little more than half of one major day's worth of asset purchases, for the startup of 5,000 validly formatted new business enterprises, then to $7 billion, almost all of just one major day's worth of asset purchases, for the startup of 7,000 validly formatted new business enterprises. A validly formatted new business enterprise is one with a valid business purpose and whose management is mentored by the SBA's resource partner the Service Corps Of Retired Executives. The SBA will manage the Perpetual Subordinated Capital Securities positions purchased by the Federal Reserve System. Transactions will be executed on a first come, first served basis, venture capitalists aka vulture capitalists neither welcomed nor required.

The Next Stop In Obama's Political Suicide Tour: Announcing Social Security Cuts During State Of The Union Address

Obama's latest quid-pro-quo with the republican party over a doubling down on fiscal stimulus in the form of mutual back scratching, funding by yet another trillion in debt, may have well be the start of his toxic spiral to the the bottom of political insignificance. According to Politico, "The tax deal negotiated by President Barack Obama and Senate Republican leader Mitch McConnell of Kentucky is just the first part of a multistage drama that is likely to further divide and weaken Democrats." Next up on the path of what many see as the terminal alienation of the president from his liberal constituency, will occur during the next State of the Union Address, when the teleprompter in chief is expected to announce cuts in Social Security, according to Politico which quotes "well-placed sources." Why will the president pretend to espouse even an ounce of fiscal prudence? Because, around that time the discussion over the US debt ceiling will be in full heat: we expect total US debt to be about $14.1 trillion by the end of January: just a $200 billion buffer from the debt ceiling breach. Therefore, as Robert Kuttner of politico speculates: "The idea is to pre-empt an even more draconian set of budget cuts likely to be proposed by the incoming House Budget Committee chairman, Rep. Paul Ryan (R-Wis.), as a condition of extending the debt ceiling. This is expected to hit in April." And as Kuttner once again phrases it best: "How to put this politely? For a Democratic president, this approach is bad economics and worse politics."

A Glimpse Of Paulson Dumping Stock: Fund's Sales Of LNG Accounts For 12.4% Of Last Ten Day ADV

Paulson is now in stock dumping mode. Whether it is on a name by name basis or wholesale is unknown right now, and will need to wait until February 15 for confirmation, although we are confident that what Paulson & Co.'s 8 different funds/accounts are doing in Cheniere Energy (LNG) in the past 10 trading days is indicative of a broad based portfolio profit-taking, that has started on November 16 and is ongoing through today. As Paulson had a sizable stake in LNG, he was obliged to file 13D's. That is not the case in most of his other positions. And courtesy of the last two 13-D (here and here), we have a glimpse of what an active dump looks like for John Paulson. Between 7 different funds and separately managed accounts, Paulson has taken his stake in the firm from 7.5 million shares to just over 2.8 million. On the first day of the dump, Paulson sold 2 million shares, representing 20% of the ADV, as the VWAP algo was working overdrive. Subsequently, Paulson sold slightly less, averaging just under 500,000 shares a day, and representing less and less of the average daily volume, until we another volume pick up today, when the selling popped to a 4 day high. Altogether one fund's selling was responsible for 12.4% of the average volume in the stock in the past two business weeks. It seems Paulson believes he has overstayed his welcome in the LNG terminal operator, in which he built up an initial 4.7 million share stake in the June 30, 2008 quarter at around $5.50/share, and then buying another 2.8 million shares in the end of 2008 at a far lower price. Then as a result of the recent surge in the name, he has decided to bail. As noted earlier, we are confident this is not an isolated case of derisking, and is likely matched by many other Paulson positions, especially in winning names in which the billionaire is now locking in profits.

Guest Post: The Curse of Fiat Money

It may come as a surprise to many, but the relative size of the US commercial-banking industry has not declined following the so-called credit-market crisis, which developed in the second half of 2007. On the contrary, it has increased since then. While nominal GDP rose 4.2% from the second quarter of 2007 to the second quarter of 2010, banks' total assets rose 18.4%. In a recession one would expect an unwinding of credit-financed investments that have turned sour. Economically unsuccessful firms go out of business, malinvestment is liquidated, losses reduce investor equity capital, and the cost of borrowing increases, providing incentives for reducing overall indebtedness. However, this is not what happened in the banking industry as a whole. The Federal Reserve, in an attempt to prevent the bank system from collapsing, supplied any amount of base money that was deemed necessary to keep banks afloat. This can be illustrated by the drastic increase in banks' base money holdings since around the third quarter of 2008.

Weekly Credit Summary

Spreads closed considerably wider today, with the biggest close-to-close widening since 6/22, as HY dramatically underperformed (pushing back above 600bps for the first time since 7/7) with the macro fears that we have been discussing crystallized and micro issues seem to be turning the same way.

Dismal confidence data along with more worrisome in-/de-flation data set the early tone and stocks and spreads pushed quickly lower (wider) out of the gate. The eight day rally that we have seen, and we have been vociferous in our view of what caused this and what was under the surface, was an exact mirror of the rally a month ago in credit. The swing from wides to tights from 6/10 to 6/21 (8 trading days) was 132 to 104.125 (which was the swing tights since 5/10's 95bps). The recent swing from 7/1 wides to 7/13 tights (126.755 to 106.5) was also over 8 trading days and the same pattern of index outperformance of intrinsics was very evident - which supports our thesis of macro hedge unwinds and underlying selling.

CDS Traders Attempting Another European Ambush

Another week, another major derisking of European names. While the drop of China out of the Top 10 can only be attributed to the summer doldrums, the top countries are mimicking the World Cup Final, and are all European, amounting to over $1 billion in net notional derisked in the past week. These are Germany, Italy, Spain, Austria and the Netherlands, with Greece and Poland at 6 and 7, and Brazil, South Africa and Colombia rounding out the top 10. On the other end, by a smaller margin, the rerisking of France and Portugal amounted to just over $500 million in the past week. The most active name was Brazil with 1,109 contracts unwound or almost $10 billion in notional, even as the net change was one of derisking. It appears Europe will have no peace from CDS "speculators" testing out the ground in each and every country, until it the rolling wave of defaults finally sets in as Niall Ferguson stated earlier.

The CDS Wolfpack Is Now Coming After France... China

A month ago, Sarkozy was pissed that Merkel had dared to take the initiative over him and to ban naked CDS trading. Being a stubborn reactionary, this action only prolonged his inevitable decision to do the same (because politicians, being the wise Ph.D's they are, realize fully all the nuances of screwing around with the financial ecosystem). However, looking at this week's DTCC data, we have a feeling he may accelerate his decision to join the CDS-ban team. With a total of 456 million in net notional derisking, France was the top entity in which protection was sought in the past week. In a very quiet week, where the 5th most active name did not even make it past the $100 mm threshold, France was more than double the number two sovereign - Mexico (we are unclear if this is some sort of contrarian move to the Yuan reval, which Goldman was pitching as MXN positive, which means traders likely hedged by loading up on Mexican CDS). But what is probably most notable, is the sudden and dramatic appearance of China in the top 3rd position. Welcome China! And after tonight's surprise PMI miss and the resulting market drubbing, we are confident within a week or two, China will promptly become a mainstay of the top 3, and will quickly rise to the top position, where it rightfully belongs. We are also confident those perennial Eastern European underdogs, Romania and Bulgaria will shyly make an entrance in the top 10 next week.

Daily Credit Summary: June 29 - Equity Catch-up

Today's action in CDS land was negative pretty much across the board with breadth extremely negative as only a handful of single-names managed to eke out gains as there was a quite evident up-in-quality shift. HY names handily underperformed IG names on the day. High beta IG names also underperformed significantly as off-the-run indices underperformed on-the-run once again and the Top 100 CDO referenced names significantly underperformed the broad market.

Daily Credit Summary: June 24 - Risk Never Left (But Italy Did)

Greece was the standout in Europe (and in fact across most sovereigns) with a 60bps decompression today (closing below 1000bps but managing to get above and trade handily upfront for much of the day). This is a 200bps decompression since the roll and while volumes remain marginal, bonds have weakened with the 2-5Y range inverting even more significantly. Calls for 50% haircuts on Greek sovereign debt in the stress tests, and an increasingly glib view of the effectiveness of the stress tests saw FINLs shift wider once again with SEN and SUB moving pretty much in line and notably FINLs and ExFINLs not decompressing. This is interesting as perhaps we are seeing the contagion leaking back into non FINLs (which would make sense via direct channel from lending/credit as well as indirect via austerity/growth slowing).