Late-Day Reality Check On Dramatic Risk Off Day

ES tumbled back down to its VWAP at the close of the day session after mounting a run back towards 1200 in the afternoon. This equity move was the second total disconnect from credit markets of the afternoon and reverted back to credit's sanity though HYG was clearly the instrument of choice (once again) for credit hedgers looking for lower cost shorts or liquid hedges. The USD was modestly higher from Friday's close and Oil rallied back this afternoon to almost perfectly match the USD shift. Gold, Silver, and Copper all lost significant ground (around 2.5%) though all were well off their early European-close-liquidation lows. TSYs rather interestingly closed near the high yields of the US day-session - though well down on the day - as 2s10s30s and Oil were the main drivers of broad risk-asset strength. CONTEXT remained notably below ES all day - maintained by the weakness in Gold, 10Y, and AUDJPY as the EURJPY ripfest into the EU close helped the risk-on crowd modestly. It was a muddled day with correlations breaking down and dramatically illiquid-looking moves as the late-day drop on very large volume suggests some sense of sanity with the uncertainty we face was priced in.

The US equity and credit day had 4 clear episodes today from our perspective. 1) pre-open ramp in ES into the open to entice would-be dip-buyers - credit ignored it almost completely and CONTEXT remained significantly down; 2) As selling picked up, HYG became the instrument of choice for shorts/hedgers and notably underperformed both stocks and HY spreads, markets converged back at the lows into the European close and were helped a little of the lows by a completely news-less 60 pip ramp in EURUSD; 3) Some chatter about the possibility of the super-committee still coming up with something pushed a little risk-on but in our view this was much more algo-driven in low volumes as we reverted perfectly and stalled at VWAP -note that HYG did not move on this rally at all; and 4) another surge for 1200 and the open of the day session moved everything higher but ES was the highest beta and most extravagantly out of sync - only to revert back in line with IG and HY credit.

HYG's relative underperformance, and SPY's late day catch up are most evident when judged from the full capital-structure perspective (since the relationship between stocks and credit is not linear). Based on VXX (vol), TLT (rates) , and HYG (credit), SPY was interestingly outperforming most of the day (as we noted above). Perhaps it is the liquidity in HYG (relative to HY bonds) and the leverage in VXX that was the driver but the SPY Arb model framework showed the basket indicating more selling pressure with two retracements and a perfect sync into the close as SPY sold off back to meet its much less sanguine counterparts. The shift in the model price was also driven by TLT's relative underperformance in the afternoon - as intruiguingly TSYs hung closer to their day-session high yields than risk-asset weakness might suggest.


At the close HYG was marginally off its lows while ES, HY, and IG were about mid-session levels. We urge a close inspection of shares outstanding for HYG as if we start to see the destruction of units (as opposed to creation units) then we know the secondary HY bond market cannot withstand that pressure and could quickly deteriorate. We have warned of the extreme level of the advance-decline line for HY debt recently and remind readers that we also noted the 'stuffing' of the HYG ETF which we suspected was going on. The last few days has seen HYG underperforming, shares-outstanding stable (not rising anymore) and Advance-Decline rolling over very fast - worrisome.



Today's secondary bond trading was thinnish (technical term) with HY seeing balance (modest net-selling) and IG modest net-buying). The focus seemed to be on up-in-quality as HY rotations into AA-BBB was most evident. The rise in TSY 2s10s30s was mirrored in Corporates with the 1-3Y most net sold and the <1Y and >12Y seeing the most net buying. It was clear that short-dated financials (BAC, JPM, BNP, ALLY) were among the largest net sold (get me out!) and there was modest duration extension into the 1-3Y higher quality (low spread names).



FX markets saw three regimes, flattish overnight, higher volatility during the European hours, and then flattish during late day US. This makes sense and we suspect the late surge in EUR against the USD was more liquidity-based USD liquidation and EUR repatriation - TSYs did sell-off into that period also. AUD was the currency today as carry trades were tossed.


Commodities in general rallied from around the end of the European day - suggesting the liquidations were European-firm-driven. Oil managed to scamper all the way back up to perfectly sync (its loss) with the dollar's gain today and Copper, Gold, and Silver (while notably volatile intraday) seemed to miraculously converge into the close at around 2-2.5% losses from Friday's close. Silver managed a 3% rally off its intraday lows.

Taking into account CONTEXT and the empirical relationship between HY and equity markets through various business cycles, the S&P 500 got its closest to some semblance of value relative to credit in over a month. 1164 is the current expected fair-value for the S&P (which can be monitored intraday here).


Charts: Bloomberg


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