Capital Context Update: Little Ado About Something

From Capital Context

Volume rose dramatically
as we sold off and disappeared
during the day session's
rally back to unch.

Another interesting day where headline performance comments will mask what was really going on under the covers. The S&P 500 managed a small gain on the day as did IG (investment grade) and HY (high yield) credit spreads at the index level as VIX reached its lowest since 2/18 - all good right? We hate to burst this bubble of ebulience, and we do note that what positives there were at the index level were minute anyway, but bottom-up painted a very different picture in credit and vol land and as the chart opposite shows, equity volume dried up as we rallied back to the green line.

An 'orrible morning in Europe (discussed in the Midday Movers ) combined with a decent miss on jobless claims and hotter than expected core PPI sent us on a path lower pre-open today in S&P futures and both IG and HY credit was gapping up to two-week wides. Within an hour of the open, there was a bid to the market and while credit was not playing the game out of the gate (like stocks were), it too got caught up and indices slipped tighter - ending very modestly tighter on the day as S&P futures closed with a late day languish into the red.

What was most interesting was the fact that the underlying single-names in credit saw very negative breadth today and most critically we note that the fair-value for the HY index (the weighted sum of the 100 components) reached its widest level since 1/10 and is now 60bps wider than its tights in mid Feb. Year-to-date, the S&P is +4.5% or so but IG and HY credit are as good as unch (carry aside) in spread terms and credit has been widening (getting riskier) since mid-Feb in a relatively consistent manner.

We have discussed how secondary bonds have been showing less systemic buying recently and have noted that the major liquid credit derivative indices have been underperforming suggesting macro overlays being laid out (protecting gains on considerably less liquid underlying bond/credit portfolios with a more generic liquid hedge). Today saw considerable underperformance among individual credits relative to the indices and we suspect the unwind of idiosyncratic longs and systemic short hedges (taking off the macro hedge piece by piece as you cover your underlying longs) has started to occur.

This was the most notable divergence we have seen in a while (weeks/months) and while it is not a red-alert, it is noteworthy to us that credit market professionals are less comfortable with risk here. We also saw 3s5s flatteners in IG and HY and while the indices are trading modestly cheap (wide) of fair-value (and so some index arb may have been at play), the underperformance of lower beta credits (over higher beta credits) suggests perhapos investors looking for cheaper basket protection hedges.

  There were seven wideners to every tightener today in credit markets and while moves in general were not large (aside from the idiosyncratic names we discuss below), they were under pressure all day - not compressing from the open like the indices did. Dispersion rose once again and the up-in-quality theme continues.


We find it fascinating that the pop in PPI which caused TSY yields (caused or was coincident with) to increase helped the 2s10s30s butterfly, that we have been keeping an eye on, to increase. This increase seemed to provide the juice for the rise in equities today and as you can see in the chart opposite - the tick-for-tick moves in the last few days (a new regime from the previous few months) is very notable. We also note that GC repo popped 10bps today from very low levels in overnight - did anyone hear the Fed doing reverse repos? Anyway, TSY yields were all higher today 2s10s steepening and 10s30s flattening (as auction fever hit once again at the long end).

Silver made new highs (above $42) and gold egded close as the Dollar (in it all its guises vs Majors, Asian FX and Trade-weighted) lost ground and DXY is getting very close now to the 2009 lows.

A mixed picture contextually
but Consumer Noncyclicals
outperformed in stocks while
Financials and Media underperformed
relative to credit.

Contextually , credit and vol were much clearer about their directional view today (deteriorating) than stocks (mixed) . Financials saw modest vol compression but the rest saw vol increase on average at the sector level. Tech, Energy, and Media were the worst (risk-adjusted) performers in credit while Financials and Media were worst on average in stock land (risk-adjusted). Interestingly equity outperformed credit (divergently - as in equity rose and credit widened on average) in Basic Materials, Consumer Noncyclicals, Energy, Healthcare, Tech, Telecoms, and Utilities and the fact that Utes and noncyclicals were the best risk-adjusted performers in stock land suggest less rotation out of stocks and more rotation across sectors today.

Similar to our midday update, implied vol followed credit topday witgh the better quality names (rated A and above) seeing modest spread compression and vol decreases while lower quality (rated BB- and below) saw vol increases and spread decompression. The picture in stocks was mixed though lower quality names did underperform.

DYN, EK, HOV, HON, and THC saw the largest (risk-adjusted) deterioration in credit today and SVU, TE, MCD, DTE, and SO were the best risk-adjusted performers. DYN, SVU, and EK were once again at the top of the list of divergences (credit considerably underperforming equity on a risk-adjusted basis) while Shaw Communications, HAS, DELL, and HSP were the most divergent witth compression in spreads and drops in stock prices (basis adjusted). The divergences in that direction (credit favorable, equity unfavorable) were dominated by releveraging names (or event risk prone names) - LBO/M&A premium coming out?

The Bottom Line for us is that we feel an escalation of some derisking is occuring in credit and we would remain comfortably hedged in any long equity position (in fact our TAA model has started to drop the weighting to equities recently). Many of the themes and suggested trades of recent weeks are starting to gather pace - though nothing startling yet - but under-currents in credit (and vol surfaces) suggest more than the simple close-to-close unches in equity markets is underway.

Index/Intrinsics Changes

CDX16 IG -0.48bps to 94.52 ($0.02 to $100.21) (FV +0.91bps to 93.34) (100 wider - 10 tighter <> 63 steeper - 59 flatter) - No Trend.

CDX16 HVOL +1bps to 154 (FV +1.34bps to 152.76) (26 wider - 3 tighter <> 20 steeper - 9 flatter) - No Trend.

CDX16 ExHVOL -0.95bps to 75.74 (FV +0.77bps to 75.27) (75 wider - 21 tighter <> 52 steeper - 44 flatter).

CDX16 HY (30% recovery) Px $+0.13 to $102.315 / -3.1bps to 442.7 (FV +6.32bps to 433.62) (91 wider - 8 tighter <> 36 steeper - 64 flatter) - Trend Wider.

LCDX15 (70% recovery) Px $-0.05 to $101.375 / +1.24bps to 239.9 - No Trend.

MCDX15 -0.5bps to 150bps. - No Trend.

ITRX15 Main -0.25bps to 97bps (FV+2.01bps to 100.29bps).

ITRX15 HiVol -0.02bps to 135.61bps (FV+2.06bps to 133.34bps).

ITRX15 Xover +1bps to 369bps (FV+4.55bps to 359.3bps).

ITRX15 FINLs -1.25bps to 128.25bps (FV+4.92bps to 133.37bps).

DXY weakened 0.36% to 74.71.

Oil rose $1.33 to $108.44.

Gold rose $18.1 to $1475.4.

VIX fell 0.65pts to 16.27%.

10Y US Treasury yields rose 3.9bps to 3.5%.

S&P500 Futures gained 0.17% to 1310.9.

Spreads were mixed in the US with IG tighter, HVOL wider, ExHVOL better, and HY rallying. IG trades 3.5bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.1s.d.. At 94.52bps, IG has closed tighter on 141 days in the last 589 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 17.7bps wide (cheap) to its 50d moving average, which is a Z-Score of 1.1s.d. and at 442.74bps, HY has closed tighter on 60 days in the last 589 trading days (JAN09).

Indices generally outperformed intrinsics with skews mostly narrower. Comparing the relative HY and IG moves to their 50-day rolling beta, we see that HY outperformed by around 0.4bps. Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks underperformed HY by an equivalent 1bps, and stocks underperformed IG by an equivalent 0.1bps - (implying IG outperformed HY (on an equity-adjusted basis)).

Among the HY names in the US , the worst performing names (on a DV01-adjusted basis) were PMI Group Inc/The (+64.47bps) [+0.53bps], Radian Group Inc (+39.74bps) [+0.36bps], and Eastman Kodak Co. (+34.52bps) [+0.28bps], and the best performing names were Energy Future Holdings Corp. (-108.34bps) [-0.73bps], Supervalu Inc. (-52.84bps) [-0.49bps], and Alcatel-Lucent USA Inc. (-15bps) [-0.15bps] // (absolute spread chg) [HY index impact].

Among the IG names in the US , the worst performing names (on a DV01-adjusted basis) were SLM Corp (+6.96bps) [+0.05bps], Expedia, Inc. (+3.79bps) [+0.03bps], and RR Donnelley & Sons Company (+3.71bps) [+0.03bps], and the best performing names were CA, Inc. (-1.5bps) [-0.01bps], Sara Lee Corp. (-1.02bps) [-0.01bps], and General Mills Inc. (-0.75bps) [-0.01bps] // (absolute spread chg) [HY index impact].