Capital Context Update: Dispersion Rising

From Capital Context

HY underperformed once again and while close-to-close comparisons will leave most with the perspective that it was a dull day, we see rising dispersion as investors begin to differentiate names more effectively. After reaching down to yesterday’s lows/wides, both IG credit and S&P futures managed to creep back up to close all but unchanged. Intraday swings were much less in credit than equities though but post Obama’s deficit speech we did see a continuation of the up-in-quality trade in credit as stocks limped back up to VWAP (only to lose it to the downside into the close).

This week has seen a re-emergence in the 2s10s30s correlation (tick-for-tick) with S&P futures.

There seemed little impact in the US from what macro data we saw today as retail sales managed a modest beat and inventories came in lower than expected but it was enough to get us up to Friday’s low print in S&P futures (and Friday’s wides in IG credit) before the bell. That was the best we saw for the day as we slid for the rest of the day as JPY-based carry pairs increased their dispersion and dropped in general (AUDJPY was pretty much unch close to close). HY and IG closed pretty much at their wides of the day (with HY legging down further after the close) even with breadth relatively strong in single-names (more index overlays as we have seen IG widen 6 of the last 7 days and for 5 days in a row).


This dispersion reduces the FX carry trades ability to drive risky assets (think US stocks) and we note that once again DXY, ADXY, and TWI USD did very little on the day. We discussed carry trades at length recently but point out that the rise in vol among FX pairs reduces their attractiveness (even if intervention is on your side) and the elimination of the GC-IOER arb maybe has forced firms back into the ride-the-curve trade that was so popular in Q2-3 2009 – the 2s10s30s carrry trade. Gold and Silver outperformed the dollar today but moves were not as spectacular as in recent days and certainly showing no signs in the latter of the pullback we expected (though we favor Gold longer-term over the higher-beta silver – its better for our heart that way).

The main themes that we see evolving are a modest rotation from equity to credit (reducing beta overall) and the up-in-quality shift in credit – favoring IG credit (safety or sanity?) – both of these are causing a useful rise in dispersion among credits and equity relative valuations. Issuers are taking advantage and the calendar remains heavy (much more IG than HY though – its not quite as easy as it was) with AA’s 10Yr note issued at a rather surprisingly $2.7 rich to the implied CDS curve’s value (someone wanted/needed some barely IG paper to fill their book and was willing to pay up) as AA’s CDS curve steepened on the day.

All this frivolity in the primary market is certainly not indicated in secondaries though where we see another mixed picture today when looking at TRACE flows. Not only are we seeing more divergence among the sectors and rating cohorts on a day-to-day basis but the action is becoming more consistent rather than one-off derisking days. We had mentioned some expectation of a more idiosyncratic unwinding in secondaries (and single-name CDS) after the initial index overlays of the last few weeks, and we are starting to see it in bonds now – despite another week of decent inflows (except for poor old Munis).

Today saw net selling pressure overall in secondary bonds from the buy-side among TRACE flows with Tech, Cons NonCycs, and Financials. Basic Materials was sold the most which we suspect was to make room for the new AA issue (which topped the sold list in that sector) but certainly seems like buy-side bond chaps are cooling on the idea of Miners and preferring Ags (despite silver and gold managing modest gains on the day and closing near highs of the day).

Treasuries saw 10Y and 30Y outperforming as 2Y rallied but stabilized for much of the late day. 5-6bps of compression in yield at the longer-end impacted thge 2s10s30s butterfly that we mentioned and certainly didnt help stocks on that side. The duration extension in Treasuries was also evuident in corporates with 1-12Y buckets seeing net sellers while bonds more than 1Y maturity were actively bought (the super short-end <1Y was bid also).

Vol was relatively uneventful top-down as OPEX dominates once again but we did see skews modestly rising and note that single-name vol was bid relative to indices which is reflected in the drop in implied correlation (but we suspect this is OPEX related as much as any real flow).

HY dispersion has begun to rise notably and IG is starting to rise recently.

In pure credit land, you may be able to tell but we are noticing a significant pick up in dispersion or more accurately a bigger focus on idiosyncratic risks. Correlation (equity and credit implied) has dropped modestly recently but less technically the distribution of spreads is increasing and skewing wider as lower beta names are outperforming modestly. As is usual, HY dispersion will tend to rise before IG (as distressed names are singled out – see Dynegy today!) but even with the up-in-quality trade that is playing out recently, IG is starting to shift also. The chart is comparing high and low percentiles for the current IG and HY index names. A focus on credit fundamentals may just pay off at this point (as opposed to blindly buying everything systemically which we say oh-so-irreverently) especially if we see the credit cycle turning as we suspect it is.

Aggregating all our bottom-up name performance saw our brioad credit index rally modestly on the day (reflecting what we said earlier about positive breadth) as tighteners outnumbered wideners by just under 3-to-1. Most sectors rallied on average except for Capital Goods, Media, and to a small extent Basic Materials. Leisure and Consumer Cyclicals saw the best risk-adjusted performance on the day. It is worth noting though that moves were very small in general (less than 1% of all names moved more than the aggregate average) as most concentrated on a handful of idiosnycratic names and the indices (while the rest were just reracks from dealers). It was not until spreads traded above 500bps did we see any names really moving and the bias there was wider (consistent with our earlier observations).

YRCW, MBIA Inc, Polyone, Cablevision, and Gap Inc. were the risk-adjusted worst performers while Community Health (over-reaction yesterday?), MGM Mirage, RESCAP, Continental Airlines, and JetBlue were the best risk-adjusted performers in credit today. Transports were worst while Gaming (high beta and small industry) was best on the day.

Contextually, today was much more about implied vol moves than credit or equities with the latter two practically unch at the aggregate average while vols rose in all but financials. Only 36% of our universe agreed on direction today (24% improving and 12% deteriorating) and the remaining 64% were split 29-35 in favor of credit outperforming while stocks dropped. Tech was only sector to see average spreads widen while average stocks rose in price as basic Materials, Capital Goods, Healthcare, and Consumer (Cycs and NonCycs) all saw average spread compression while average stock prices fell.

Lunchtime themes remained mostly in tact with lower quality credits underperforming in vol (rising vol) and CDS (widening spreads) relative to higher quality but we did see the crossover space (BBB+ to BB) dominate the best performing stocks today. Stocks definitely rotated out of Capital Goods (as we said in the Midday Movers) while credit was unch for these lower beta names. Dynegy was the worst reklative performer (and we note we have been highlighting it recently from a credit perspective) as new broke of its hiring a restructuring firm (5Y spreads >1200bps now).

The Bottom Line for us is that 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.


Not a very pretty day in Europe as it look sincreasingly like Greece will restructure and growth expectations are slowing in general. SovX moved back above 170bps and we saw further decompression in financials (most notably the rise the senior-sub spread is telling). Financials underperformed non-financials but we did see XOver tighten modestly as its higher beta names (Dixons for instance) rallied handsomely and steepened.

The weakness in Main (especially given our comments above on the US up-in-quality trade) is driven almost exclusively by the decompression in financials. Remember that Main is exposed to much more mainstream financials than IG is in the US (more insurers). In fact Main ex-financials actually managed a 0.5bps tightening today as financials widened 2bps.

EM risk has stopped rallying in the last few weeks as the rise in oil prices potentially swings from profitability to demand destruction.

All of the major and peripheral European countries saw their spreads widen today – some considerably – and we note that Spain is now above 220bps (25bps wider this week alone). The recovery from intraday lows for Brent priced in EUR today managed to help many of the CEEMEA names recover as they outperformed SovX notably. Slightly off topic, we do note that EM spreads have not particpated in the ebulience of the oil market (and its expected windfalls?) as much as we might have expected suggesting credit market participants see less sanguine growth for these nations (or more likely just a rise in turmoil that necessitates relatively wider spreads). It seems that once we get past a certain price in oil (around $65 for Brent in EUR terms) that the balance between the producers (which dominate the EM index) and growth/turmoil becoems more balanced – just a thought.


Asian sovereigns were mixed to modestly tighter with only NZD slightly wider. While not exactly Asia, we note that ZARJPY was the worst performing carry pair while NZDJPY was the best today (almost a 2% divergence between the two) as we discussed above with the dispersions among these pairs. Asian banks were the worst hit overnight but at the aggregate both Japan and Asia Ex-Japan managed to tighten modestly today with Japan outperforming (we suspect on more government LSAP efforts).

Aussie spreads were very weak idiosyncratically (though unch at the index) once again with financials underperforming (in our favor for our systemic short Aussie financials vs ITRX AUS). Wesfarmers and CSR were the worst relative performers on the day.

Index/Intrinsics Changes

CDX16 IG +0.12bps to 95 ($0 to $100.19) (FV -0.31bps to 92.61) (24 wider – 64 tighter <> 56 steeper – 62 flatter) – No Trend.
CDX16 HVOL -0.3bps to 153.5 (FV -0.3bps to 151.65) (7 wider – 17 tighter <> 16 steeper – 13 flatter) – No Trend.
CDX16 ExHVOL +0.25bps to 76.53 (FV -0.3bps to 74.66) (18 wider – 78 tighter <> 55 steeper – 41 flatter).
CDX16 HY (30% recovery) Px $-0.19 to $102.19 / +4.7bps to 445.9 (FV -3.08bps to 426.55) (25 wider – 60 tighter <> 53 steeper – 44 flatter) – Trend Wider.
LCDX15 (70% recovery) Px $+0.06 to $101.375 / -1.53bps to 238.75 – No Trend.
MCDX15 -0.25bps to 150.25bps. – No Trend.
ITRX15 Main +0.25bps to 97.25bps (FV+0.81bps to 98.29bps).
ITRX15 HiVol +0.25bps to 135.75bps (FV+0.48bps to 131.17bps).
ITRX15 Xover -2bps to 368bps (FV-5.56bps to 353.56bps).
ITRX15 FINLs +2.75bps to 129.75bps (FV+2.19bps to 128.6bps).
DXY strengthened 0.19% to 74.99.
Oil rose $0.99 to $107.24.
Gold rose $3.7 to $1456.8.
VIX fell 0.17pts to 16.92%.
10Y US Treasury yields fell 3.4bps to 3.46%.
S&P500 Futures gained 0.02% to 1308.6.

Spreads were mixed to mostly wider in the US with IG worse, HVOL improving, ExHVOL weaker, and HY selling off. IG trades 4bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.3s.d.. At 95bps, IG has closed tighter on 143 days in the last 588 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 17.4bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.4s.d. and at 445.89bps, HY has closed tighter on 65 days in the last 588 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 4bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 5.6bps, and stocks outperformed IG by an equivalent 0.3bps – (implying IG underperformed HY (on an equity-adjusted basis) but moves were rather small today in general).

Among the IG names in the US, the worst performing names (on a DV01-adjusted basis) were RR Donnelley & Sons Company (+3.5bps) [+0.03bps], Dell Inc. (+3bps) [+0.02bps], and SLM Corp (+3bps) [+0.02bps], and the best performing names were Alcoa Inc. (-4bps) [-0.03bps], ERP Operating LP (-2.25bps) [-0.02bps], and Caterpillar Inc. (-2bps) [-0.02bps] // (absolute spread chg) [HY index impact].

Among the HY names in the US, the worst performing names (on a DV01-adjusted basis) were Levi Strauss & Company (+10.25bps) [+0.1bps], Rite Aid Corp (+11.92bps) [+0.1bps], and Belo Corp (+7.5bps) [+0.08bps], and the best performing names were Community Health Systems Inc (-34.75bps) [-0.33bps], Tenet Healthcare Corporation (-19.16bps) [-0.19bps], and Residential Capital, LLC (-17.5bps) [-0.18bps] // (absolute spread chg) [HY index impact].