Market Snapshot: What's Left?

What was already a relatively volatile morning leading up to the European close, paused for an hour or two until the FOMC statement was released with TSYs unch and ES at VWAP right before. Immediately, stocks ripped and dipped, the TSY curve started to flatten - pivoting around the 7-10Y, the USD took off, commodities and PMs dropped, and credit cracked wider. Somewhat interestingly, while all this chaos was occurring, ES remained relatively well behaved with regard a broad basket of risk assets - which while not a positive per se, did indicate that this was a very broad de-risking and not simply a US equity market prone to vicious dips, rallies, and retracements. It seems very obvious now, and fit with our indications of an exuberant equity market relative to the 2s10s30s fly, credit, and risk in general, that the rally in equities (which baffled anyone with common sense given the background of worsening macro data) was on pure hope and perhaps the sell-off's harshness today will have burned a few fingers as it seems the Bernanke Put strike just moved a lot further out-of-the-money.

Chart: Capital Context

As we closed, ES was perhaps a little overdone relative to a broad risk-basket but it certainly showed no sign of pulling back right into the 415ET close - only 1pt off its lows.

The Treasury complex was the story of the day (in terms of volatility-adjusted smash-mouth moves) with 30Y 30bps lower in yield from Friday and 19bps alone today. The whole curve flattened but it was the sell-off in the front-end that was notable with 2Y and 5Y +3.6 and 1bps higher in yield on the day respectively.

It was the highest beta sectors that obviously saw the most pain today with some of the major financials decimated. Financials wewre the hardest hit today -4.8% but Materials, Industrials, and Energy were also very weak. Tech outperformed and remains the only sector that is positive for the month of September now.

Financials are the worst performers for the month so far down around 11% - hardly surprising given the crutch of government support being taken away (and the removal of yet another source of easy money - the curve carry trade) - BAC -7.4% today lone ending at its low around $6.39.

The lack of LSAP-speak from Bernanke saw a relatively weak USD, as we went into the witching hour, take off - up over 1% today alone and of course this had a significant impact on the commodities and precious metals space. Gold, Silver, Copper, and Oil all fell after the FOMC statement with oil dropping the most and gold the least with oil and copper at the week's lows.

Credit markets were just as weak as equities with both the new IG index (which we noted was already relatively offered anyway) and the legacy HY index both losing significant ground on the day. In fact IG underperformed on a beta-adjusted basis as we suspect managers grabbed at whatever the cheapest hedge was in hope of saving some face on the day. By the numbers, IG17 ended the day around 8bps wider at 141.5bps, while intrinsics widened only 4-5bps as liquidity and pressure stayed in the index hedges - reracks tomorrow morning will be exciting. HY16 ended +37 at 705bps while intrinsics only widened 16bps - again clearly a mad scramble for liquid protection as we sold off this afternoon.

Corporate bonds appeared relatively net bought reflecting almost perfectly the shift in TSYs with the belly being most bought and short and long ends of the curves being least bought. Most notably was the underperformance of CDS indices relative to their underlyings. Chatter was that today was very much a buyer's strike in corporates as opposed to too many sellers as it is increasingly clear to everyone in the HY market especially that too much selling will tip this market down fast. It was clear that managers were using index overlays as opposed to rushing for the exits in their bond funds today and as we have noted before - as the basis between index marks and underlying portfolio illiquidity increases (especially if we some heavy concessions in new issuance) then pressure will come on bond fund managers to liquidate as opposed to manage risk - we love the smell of BWICs in the morning.

This reach for macro hedges fits well with our recent discussions of the normalization in the volatility markets - i.e broad investor base is not/less hedged. Today we saw the VIX rise and skews steepen as they start to converge up to where we discussed implied correlation was betraying they should be.

Charts: Bloomberg

UPDATE: we have had a number of comments/questions on whether this sell-off has legs. Of ocurse we have no idea other than, as we mentioned above, the rally seemed based on more dollar devaluation and portfolio disequilibrium which Twist is far less than expected. However, based on the long-run relationships between credit and equity markets, the following chart shows that it appears equities have further to fall until they reconnect with credit's expectation. This is of course a relative-value perspective but does warrant concern over equities' current pricing.

This stock indiator is based on the Capital Context Corporate Index. While today's sell-off in stocks did push the indicator back towards the equilibrium, stocks remain notably expensive relative to credit market expectations on an empirical basis.