Capital Context Update: Credit Where Debit Is Due

From Capital Context

S&P futures were down notably
in the pre-markett on EUR concerns.
We note the last hour found
support at VWAP and opening
day session levels.

Stocks closed down, though well off their worst levels of the day, but underperformed credit quite notably once again on a beta-adjusted basis as regime shifts for many stat arb algos were snapped early on and killed the market for much of the middle of the day in stocks. A late day surge back up to the opening level of the day session, which coincided closely with the S&P futures VWAP (the volume-weighted average price of the day that so many HFTs use), left Treasuries still the notable underperformers despite so many people claiming victory over the ratings agencies thanks to the dollar and UST moves.

We discussed some of the reasoning for these moves in the Midday Movers post, but critically there were notable regime shifts today that will bear watching for follow through as we remind readers that the US equity and credit markets were down pretty good early on anyway thanks to the continued denial-denial-denial in Europe (most notably Greece). The break between JPY crosses and the dollar, the 10Y TSY to ES link, 2s10s30s correlation to ES, Bunds vs TSYs, and gold/silver vs the dollar are all notable shifts today but once again the VIX/VXV term structure steepness of last Friday that we warned about as extreme and the continued medium-term richness of stocks to credit keep us from aggressively buying any dips here (yes our tongue is in our cheek a little there).

While we pulled back off the tights in credit as the major indices (HY and IG) followed S&P futures for the most part in the afternoon, this was still the biggest widening day in both indices since 3/21 and it is worth noting that the last time the S&P was around this range, VIX was very slightly higher and HY spreads were 12bps tighter. IG traded up to 97bps offered early on, just shy of the 97.5bps contract wides and back to 3/24 levels while HY traded at its lowest since inception of the series 16 index down to $101.685 (or ~459bps) before rallying back up to the contract's inception levels around the close - which we found coincidentally interesting.

What was most contextually notable was that while equities were dropping early on and dropped rapidly at the announcement of the S&P outlook change (around 10 S&P pts in a couple minutes), credit gapped aggressively across the chasm, took out contact wides from Friday, and kept going. HY managed to get back to offered at the bid pre-drop before turning back down into the close and so did IG - the point being we filled the gap from the pre-outlook-change in credit and then turned back wider but were unable to in stocks.

Notice 10Y Treasury's flatline
and underperformance relative
to the rest of the risk
market in the afternoon.

Stocks also failed to get back in line with Treasuries which while they staged a valiant attempt, after the initial spike higher in yields, to rally, we note the flatline performance for much of the afternoon as US equities, oil, and EUR rallied in sync once again. Did we just lose another algo regime? 2s10s30s disconnected greatly at the momemnt of the annoucnement and then spent the rest of the compressing the relationship almost perfectly - which makes us more confident that there is some real money behind that new relationship (which remember was not around a week or so ago).

In credit land, breadth was very negative as one would expect with around 12 wideners to every tightener in 5Y CDS and notably curve flatteners in 3s5s outpaced steepeners (which is unusual on a day like this where liquidity tends to pool on 5Y and the rest of the curve gets left behind for reracks overnight). We have noted the 3s5s flattening in the index for a week or two as a concern and that is clearly shifting back to the single-names now too - perhaps many managers just waiting for the catalyst to shift. Financials were the major underperformer in CDS land and did not recover as much (relatively sopeaking) as the indices or non-financials from their wides of the day - though did rally off their wides in 5Y while 3Y gapped wider and stuck there (again 3s5s flattening).

In bonds, financials saw net selling pressure from the buy-side as did Communications credits modestly with Energy notably bid on the day. Interestingly given the steepening in 2s10s and 2s30s TSYs, we saw the long-end of the corporate bond market being bought and the short-end being sold - this knee-jerk reaction to rapid rate rises is often seen as corporates 'generally' outperform on spread compression and price stability at the long-end on these moves BUT we worry that this is premature and the velocity of today's move may have mis-stepped a few managers reaching for yield and relative stability of corps over TSYs. The 1-3Yr region was the most sold on the day which fits with the short-end widening/flattening in CDS also. We wonder if we will see longer-dated vol players stepping in to arb the short-dated CDS market here with the idea of 'wings' trades outperfoming in this very binary future we face (Puts vs CDS or dividend-yield stocks vs CDS trades tend to perform the best in extreme scenarios so watch your sell-side desks start selling you on the ideas - we will publish this week some ideas on this trade).

Top-down, VIX opened gap higher and slid lower all day as did VXV but the steepness flattened a bit more into reality. Implied correlation dropped - which we suggest once again is due to the disconnect in financials which we talked about a week or two back impacting the clustering nature of the sector correlations recently. We have seen notable rises in dispersion in credit recently and slow trends down in credit implied correlation and we think sector differences are driving equity implied correlation lower also. It is worth noting that while bottom-up vols did drop from the opening reracked levels they did not drop nearly as much as the index levels and continued to follow the path of up-in-quality vol compression.

Contextually , only a very few names managed gains in both equity and credit today (an interesting bunch - MAR, TOL, HOT, DHI, PEP, and SVU) as homebuilders were interestingly near the top on the list of better performers in credit (which we suspect was related to the underperformance of the CMBX and ABX tranche markets as well as the higher beta exposure in some of the credit indices). Every sector was in agreement between credit and equity with a deteriorating move today as we note financials, leisure, and media were the worst beta-adjusted in credit relative to stocks on the day. Capital Goods, Utilities, and Consumer Noncyclicals performed the relative worst in stocks versus credit.

The up-in-quality theme in credit is increasingly leaking into vol as we saw much less impact higher in vols in better-rated credits than in lower-rated credits. This was also the picture in credit though we did see the very highest rated names underperforming (financials?). This picture was somewhat different in equity-land where BB-rated and below names saw their stocks drop far less than A- rated and above names - once again we think this is to do with both financials dominating performance as well as the typical ratings/momentum correlation unwind.

Bottom-Line : while there were plenty of significant shifts today, and we exited our very profitable ETF-based capital structure arb , we remain of the opinion that stocks have room to the downside and are not heeding the risks being called out from the archaic corners of the credit and vol space. We suspect a few algos might have been washed out early on today and while FX vol continues to rise, sharpe ratios will reduce the desire for FX-based carry leverage. Watch 2s10s30s for signals, HY credit for flows, and stay hedged in the A-List (which has outperformed recently as we expect it to do - just as the long-short book we track done considerably better).


Obviously the story of the day - oh yeah aside from the USA elephant in the room and Goolsbee's 'helpful' thoughts - was the continued destruction of any credibility for any European politician. There was littel to no let up in selling pressure as CDS and bond spreads (and yields) drifted higher all day and saw no help from any US recovery in the afternoon.

The yields of the PIIGS continue
to increase and some break
new highs - note Spain
diverging friom Italy also.

SovX closed at the wides of the channel of the last 3 months - back at mid-Jan levels while many of the underlying names broke to new record wides including Greece which traded over 1300bps early in the day for 5Y protection. Echoing the Midday Movers comments, there was widespread selling among every sovereign (though we note that USA has shifted back notably wide of Germany - which widened also today - to its widest difference in three months). This time though it did catch on and the contagion spread to non-financials more than it has in recent weeks. CEEMEA sovereigns were alo very weak today - double-whammied by the contagion and oil price drops early on.

Main Ex-Financials widened 3.5bps (the biggest single day move since inception of this contract) which we have not seen much of as it has tended to be segregated in financials recently. The spread between senior and subordinated financials rose by 6bps - now 20bps wider on the week and broke back above 100bps (to 106bps). XOver and FINLs tracked wider and underlying single-names kept pace with the index moves but we note that Main underperformed intrinsics on the day and still remains over 2bps rich - we suspect the 'cheapness' of XOver and richness of Main points to the popularity of the decompression trade and while IG (in the US) is not as rich, HY remains 10-14bps wide of fair-value in 5Y and 5-8bps tight in 3Y (again suggesting our flattener idea is catching on).

Banks dominated the weakest performers and we note Glencore (so much in the news with its IPO) is also underperforming. Only Utilities and very low beta credits outperformed today in Europe - Henkel, LVMH, and Suedzucker were among them.


Same story as the others - banks were underperformers and the rest of corporate credit and sovereign risk tended to trend along wider. Interestingly Japan outperformed today (well was unch anyway) as Asia ex-Japan widened a notable 3bps - slightly underperforming Asian sovereigns which averaged 2.5bps decompression.

Aussie was more mixed but saw a similar theme though moves were minimal at best as the ITRX AUS index widened around 1bps.

Index/Intrinsics Changes

CDX16 IG +1.5bps to 95.75 ($-0.05 to $100.16) (FV +1.45bps to 94.19) (104 wider - 11 tighter <> 51 steeper - 72 flatter) - No Trend.

CDX16 HVOL +2.1bps to 155.7 (FV +2.38bps to 154.45) (24 wider - 3 tighter <> 11 steeper - 18 flatter) - No Trend.

CDX16 ExHVOL +1.31bps to 76.82 (FV +1.16bps to 75.87) (80 wider - 16 tighter <> 55 steeper - 41 flatter).

CDX16 HY (30% recovery) Px $-0.44 to $102 / +10.7bps to 450.7 (FV +6.89bps to 438.38) (84 wider - 9 tighter <> 31 steeper - 64 flatter) - Trend Wider.

LCDX15 (70% recovery) Px $-0.22 to $101.375 / +5.63bps to 242.85 - No Trend.

MCDX15 +4bps to 152bps. - No Trend.

ITRX15 Main +4.35bps to 102.1bps (FV+3.3bps to 104.1bps).

ITRX15 HiVol +4.04bps to 140.04bps (FV+4.28bps to 138.79bps).

ITRX15 Xover +13.64bps to 381.64bps (FV+12.07bps to 368.41bps).

ITRX15 FINLs +7.38bps to 138.88bps (FV+7.63bps to 142.67bps).

DXY strengthened 0.89% to 75.5.

Oil fell $2.26 to $107.4.

Gold rose $9.65 to $1496.35.

VIX increased 1.64pts to 17%.

10Y US Treasury yields fell 3.7bps to 3.37%.

S&P500 Futures lost 1.36% to 1300.8.

Spreads were broadly wider in the US as all the indices deteriorated. IG trades 4.4bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.4s.d.. At 95.75bps, IG has closed tighter on 155 days in the last 591 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 18.1bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.5s.d. and at 451bps, HY has closed tighter on 77 days in the last 591 trading days (JAN09). Indices typically underperformed single-names with skews widening in general.

Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY underperformed by around 2.3bps (or 21%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 13.3bps, and stocks underperformed IG by an equivalent 3.6bps - (implying IG outperformed HY (on an equity-adjusted basis)).

Among the IG16 names in the US , the worst performing names (on a DV01-adjusted basis) were SLM Corp (+8bps) [+0.06bps], American International Group, Inc. (+5.34bps) [+0.04bps], and Anadarko Petroleum Corp. (+5bps) [+0.04bps], and the best performing names were Toll Brothers, Inc. (-2bps) [-0.02bps], Du Pont E.I. de Nemours & Co (-1.24bps) [-0.01bps], and Autozone Inc. (-1.02bps) [-0.01bps] // (absolute spread chg) [HY index impact].

Among the HY16 names in the US , the worst performing names (on a DV01-adjusted basis) were Community Health Systems Inc (+41.44bps) [+0.39bps], Energy Future Holdings Corp. (+43.01bps) [+0.28bps], and PMI Group Inc/The (+34.24bps) [+0.28bps], and the best performing names were Nova Chemicals Corp. (-41.25bps) [-0.43bps], Liz Claiborne Inc. (-10.51bps) [-0.1bps], and CSC Holdings, LLC (-5bps) [-0.05bps] // (absolute spread chg) [HY index impact].

For those looking for entry levels in IG and HY, our pivots suggest short credit at 97.125bps in IG and 460bps in HY and long credit at 93.5bps in IG and 436bps in HY with stops at 95.25bps for IG and 447bps for HY. From Friday's levels we would be short HY and IG credit at 456bps and 96bps respectively with stops at 447bps and 95.25bps respectively


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