Closing Context Update: Up-in-Quality Continues

From Capital Context

Sector performance open-to-close for the S&P shows Energy and Tech outperforming and Financials and Basic Materials underperforming.

Headlines will crow of the strength in equities and credit markets today, and rightly so as on a close-to-close basis, this was one of the strongest days we have seen on both sides of the capital structure in a while. However, pouring our now-traditional water on that fire is the lack of high beta participation in credit, the underperformance of financials, and the clear continuation of the somewhat more risk-averse up-in-quality trade in credit and equity markets.

As we discussed in this morning's Midday Movers , most of the action resulting in today's headline-grabbing performance was in the overnight session with both volume and momentum fading dramatically as the day wore on. The S&P drifted back to VWAP mid afternoon and stayed there until a late day surge up to the highs - perhaps on an excited anticipation of AAPL's results (and its knock on sentiment on every other tech stock). Either way, stocks were pretty much unch from their day-session opening levels until that last 30 minutes and we note that financials and basic materials were net losers on the day open-to-close in equity land and the former considerably more so in credit (e.g. WFC was 5bps wider open-to-close today ending at 79bps).


Very little changed in equities or credit from the lunchtime recap, as we suggested was likely, leaving equity markets the outperformer today (on a beta-adjusted basis over credit) and European sovereigns the lone underperformers. Credit indices modestly outperformed their underlying single-names and HY 3s5s flattened a little more (as did financials) but breadth was extremely positive (at around 13-to-1) with IG ripping back across the range to its tightest since inception and intrinsics at their tightest since 3/21 (sub 92bps). This was IG's largest close-to-close compression day on a relative basis since 3/18 (pre-roll technicals at play there) and 2/25 (less technically impacted) and the gappy nature makes us wonder if the plethora of sell-side research pumping vol strategies (in credit that is) has overloaded the boat a little with gamma.

HY , on the other hand, is only back to 4/11 levels for its intrinsic value and shifted close-to-close by its largest since 4/1. While the move today was impressive on a close-to-close basis, we stuck in a very narrow range from open-to-close of only around $0.25 and closed well short of the contract's tightest levels around $103. There were some very juicy compressions in HY names though but it may be of note that the mortgage insurers (PMI, MGIC, and Radian) all underperformed quite considerably on such a good day overall (while MBIA was among the winners). HY3s5s intrinsics has now fallen 7bps in the last two days - somewhat at odds with the compression in the indices.

Secondary bond trading confirmed the themes discussed so far with financials seeing net selling from the buy-side and another day of HY net-selling and IG net-buying pressure. Once again we also see the duration extension apparent in corporate bond land with 0-7Y bonds being net sold, 7-12Y the most aggressively bought and >12Y being bought. Looking at the data, it is apparent that buy-side firms are preferring extending duration (to reach for yield) in higher quality names and unwinding shorter-duration HY names. We think this makes sense here and it fits with our oft-discussed theme trades (up-in-quality, up-in-quality, 3s5s flattteners, and selectivity).


The FX-forward implied curve for DXY has a more hopfeul outlook now than it did at the 2009 lows (room for disappointment).

The USD was the story of the day, losing 1% close to close relative to the majors and on a trade-weighted basis. Silver was the clear high beta play on this as Gold underperformed the greenback (close to close) albeit with both making new highs intraday. JPY crosses recovered from a midday slump to rally into the close - dragged-by or dragging the equity markets is unclear.

DXY came very close to the 2009 lows that we discussed this morning leaving it very prone to a test and we note the FX forward-implied DXY curve - seen at the left - considerably more positive going forward than it was at the 11/26/09 lows (USD rate rises more likely now and priced into fwd curve?).

Vol markets had an interesting day with VIX managing to hold above 15% on the close (lower close-to-close) but considerably higher open-to-close. Implied correlation increased also off the low open, got back to unch but slipped lower again into the close (more sector 'dis-correlation' from financials?). This is a theme we have discussed in some depth - the increase in dispersion - and while today was not a great example of less systemic moves in markets, it seems pros are starting to consider this a bigger possibility (and that fits with our view that 2011 is all about alpha as the easy beta trades have gone for now). Skews actually dropped modestly today in the S&P index vol space but nothing to write home about yet - more likely reactions to the gap in the S&P as opposed to thoughtful de-skewing (another great word!).

Contextually , equities handily outperformed credit today but every sector (apart from financials) agrred on direction at the aggregate today (tighter in spreads and higher in stocks) with Energy and Tech the clear winners in the race of equity over credit. Financials was net losses in our universe of stocks while credit managed a small compression but that is close-to-close which tells a very different story from the trend we saw during the day session. Consumer credits (cyc and noncyc) saw vols rise relatively more on average than most sectors today but the relative drop in financial vols (on average in our universe) was interesting in connection with the index implied correlation in equity vol land.

Equities followed the same pattern as stocks and vol today with higehr quality names performing best relative to lower quality names but there were still some with JNJ, MCD, and UTX (reported today) all seeing much more relative bidding in equity than credit - which makes some sense given their rock-bottom spreads and the much less codependent nature of the debt-equity relationship at those levels. At the other end we saw URI, PKG, CYH, DGX, and CSC outperform in credit relative to equities today.

Bottom line for us today is that the themes are playing out still. Up-in-quality is continuing in credit even as stocks outperform and while today's ebulience will please many, we look to the more archaic for our clues to what is really going on behind the scenes (away from the algos).




At the 10Y maturity- Spain, Ireland, and Greece yields rose the most while Spain and Italy managed a small compression though we note curves flattened in all of them.

We write in detail on Europe's moves in this morning's Midday Movers , suffice it to say that little shifted after that leaving European sovereigns the major disappointers of the day (well actually mainly the peripherals). CEEMEA outperformed nicely and while Greece, Ireland, and Italy were a disaster, Italy and Spain managed to creep modestly tighter in 10Y yields (cash markets). Spain deteriorated modestly in CDS land but Italy compressed - though all saw their curves flatten somewhat - and we remind readers to check the earlier post for our thoughts (albeit very sarcastically) on the much-heralded success of the Spanish auction today (cough?yield up 30bps from prior auction?cough).

Some of this had the feel of SovX index arb as the highest beta (PIIGS) protection was bought and intrinsics underperformed the index itself compressing off its 10bps wides.

This index arb may help explain why financials in Europe never caught the cold of the sovereigns today but even though they ended tighter, the move was minimal at best and pretty much in line with non-financials. Financial senior-sub decompressed very modestly unable to break back below 100bps.

Portuguese corporates underperformed (PORTEL and EDP) while banks and consumer names topped the outperformers.


All in all a pretty solid day in Asian credits with the majority tighter as both AXJ (Asia Ex-Japan) and Japan compressed with the latter the clear outperformer. We note the trend of AXJ-JAPAN compression is now almost two weeks old and 12bps long (from 35bp)s to 23bps and while TEPCO seems to be becoming a ward of the state - the 23bps premium (relative to a general discount) to AXJ seems like a cheap bullish bet here for those who think Japan is out of the woods. Japan CDS dropped 3bps to 82bps - its tighest since the earthquake - so it would appear perhaps that the Japan-AXJ trade has some legs there also.

Australia continues to hover just wide of AXJ and with its considerable banking exposure, we have a slight bias to be short Aus credit and long AXJ credit in that pair - Aussie housing hasnt had the knock-on effect yet that we suspect will come the bank's way as rates rise and NIM drops.

Index/Intrinsics Changes

CDX16 IG -2.23bps to 92.52 ($0.09 to $100.28) (FV -1.75bps to 91.39) (6 wider - 117 tighter <> 65 steeper - 59 flatter) - No Trend.

CDX16 HVOL -4bps to 152 (FV -2.57bps to 149.95) (1 wider - 29 tighter <> 12 steeper - 18 flatter) - No Trend.

CDX16 ExHVOL -1.67bps to 73.74 (FV -1.5bps to 73.6) (5 wider - 91 tighter <> 43 steeper - 53 flatter).

CDX16 HY (30% recovery) Px $+0.5 to $102.655 / -11.9bps to 434.7 (FV -10.64bps to 422.79) (5 wider - 93 tighter <> 57 steeper - 42 flatter) - No Trend.

LCDX15 (70% recovery) Px $+0.16 to $101.375 / -4.2bps to 232.27 - Trend Tighter.

MCDX15 -2.64bps to 145.355bps. - No Trend.

ITRX15 Main -1.28bps to 99.35bps (FV-1.72bps to 101.02bps).

ITRX15 HiVol -2.22bps to 137.28bps (FV-1.49bps to 135.81bps).

ITRX15 Xover -7.06bps to 365.94bps (FV-9.45bps to 356.46bps).

ITRX15 FINLs -1.59bps to 131.91bps (FV-5.32bps to 132.72bps).

DXY weakened 0.92% to 74.34.

Oil rose $3.32 to $111.47.

Gold rose $5.66 to $1501.98.

VIX fell 0.76pts to 15.07%.

10Y US Treasury yields rose 4.5bps to 3.41%.

S&P500 Futures gained 1.91% to 1333.6.

Spreads were tighter in the US as all the indices improved. IG trades 0.9bps wide (cheap) to its 50d moving average, which is a Z-Score of 0.3s.d.. At 92.52bps, IG has closed tighter on 85 days in the last 593 trading days (JAN09). The last five days have seen IG flat to its 50d moving average. HY trades 18.3bps wide (cheap) to its 50d moving average, which is a Z-Score of 0.5s.d. and at 434.73bps, HY has closed tighter on only 43 days in the last 593 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 underperformed by around 1.1bps (or 9%). Interestingly, based on short-run empirical betas between IG, HY, and the S&P, stocks outperformed HY by an equivalent 14.8bps, and stocks outperformed IG by an equivalent 3.5bps.

Among the IG16 names in the US , the worst performing names (on a DV01-adjusted basis) were UnitedHealth Group Inc (+1bps) [+0.01bps], Fortune Brands Inc. (+0.82bps) [+0.01bps], and McDonald's Corporation (+0.66bps) [+0.01bps], and the best performing names were RR Donnelley & Sons Company (-6.47bps) [-0.05bps], Hartford Financial Services Group (-5.89bps) [-0.05bps], and GATX Corporation (-5.72bps) [-0.04bps] // (absolute spread chg) [HY index impact].

Among the HY16 names in the US , the worst performing names (on a DV01-adjusted basis) were Radian Group Inc (+32.62bps) [+0.29bps], PMI Group Inc/The (+34.81bps) [+0.28bps], and MGIC Investment Corp (+15.33bps) [+0.15bps], and the best performing names were MBIA Insurance Corporation (-111.58bps) [-0.77bps], Energy Future Holdings Corp. (-79.35bps) [-0.54bps], and K Hovnanian Enterprises, Inc. (-60.65bps) [-0.48bps] // (absolute spread chg) [HY index impact].