1100 Vs 1250 And The Sentiment Couldn't Be More Different

Via Peter Tchir of TF Market Advisors

When we were hitting 1100 the market was in deep fear mode.  Investors were on the verge of panic.  Default was on the tip of everyone's tongue.  Now at 1250, we are all waiting patiently for some positive announcements.  There is little (if any) fear out there.

I suspect LCH will retract some (if not all) of the margin hike on Italian debt.  That should give a brief spike to the market.  How much of this move is related to LCH's move is debatable, but if they go back to original margin requirements and bonds don't respond extremely well, then look out.  I actually don't think bonds will do that well, because the damage has been done, and if the LCH reverts on margin, look for articles questioning how safe the LCH is.  There is a reason they have these margin requirements - to protect the people who trade on the platform.  If they cave, expect short term bounce, but longer term issues.

Some group will make some big announcement.  The IMF or the EU will make some announcement of support and money.  The market will rally on that too.  I think though, that finally, the market will look for some substance.  It can't just be an announcement of potential money, it has to be an announcement of real money immediately.  Anything less is now likely to disappoint the market (since at 1250 we are not pricing in any real European problems).  Italy is so big, and hit so suddenly, that printing money or massive ECB purchases seem the only way out.

With banks being "clever" on how they calculate their risk, look for further problems in the inter-bank lending market.  More and more banks are going to have to go direct to the ECB for money, and I think US banks will continue to pull back lending to European banks (if they still have any lending left) as banking and politics have become too mingled in Europe to rely on traditional metrics or analysis of possible outcomes.

I got the individual investor report from someone - sentiment is decidedly bullish as the bull % continues to grow as the bear % continues to decrease.  Again, the market (away from sovereign debt itself) seems much more comfortable that a bounce is on the way.  It is almost scary how comfortable the market feels here, and I too fully expect a couple of catalysts for a bounce, but really think anything less than an onslaught of ECB purchases and money printing, will force the sell-off to resume.

While we focus on Europe, HSBC had bigger write-downs in the US.  Also, HY17, the latest iteration of the HY CDX index had 1 default - Dynergy.  Dynergy actually had a very high recovery rate as the reasons for the default are complex, so it isn't too bad.  I do not think PMI has had a Credit Event yet, but that is only a matter of time.

ResCap is suddenly in the spotlight again.Remember that "bailed out" company, well, ALLY (also in the index) just hired an advisor to figure out what to do with ResCap.  That seems to have caught the market a little bit by surprise.  Eastman Kodak has improved (a bit) but is another possibility.  So HY17, launched in September, has at least 2 defaults (out of 100 names) and may have 2 more fairly soon.  That would be a 4% default rate.  There is a lot of truth to the argument that companies have improved their balance sheets, but these are highly leveraged companies and the move to default can be quick.  With the big move in markets, it is time to focus on specific credits.  Ideas like selling 3 year protection on a name like McClatchy make sense - there could be some mark to market risk, but the company is in good shape, particularly to that maturity.  But trades like that require some real analysis. 

Just betting that the HY market as a whole is "cheap" here is dangerous.  HYG and JNK are great, but they increase the correlation of bonds during times like this.  As their shares outstanding increase, all the bonds in the index or that are possible eplacements rise with it.  As we went from 80 to 85 on HYG, that made sense.  Up here, I would want to be much more credit, and even bond specific.  Italian 5 year bonds at 7.5% yield more than HYG (7.1%) and certainly have a lot more people trying to help them.  I'm not sure I would put that trade on, but it may crowd out some investment in the high yield space, especially as we see some defaults rise.  It is a credit pickers market here, not a broad asset class decision (particularly from the long side).


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