Credit Default Swaps Show a Decrease in the Fear Trade

Credit Default Swaps (or default risk) have really come in over the last week, and as shown below, an index of CDS prices for 125 investment grade North American debt broke its uptrend and key support in recent days. A break of these key technical levels leaves plenty of room to run on the downside, which is a positive for the overall market.

Below we highlight the CDS prices for four big banks and brokers. Default risk for these companies has also dropped significantly over the last few weeks. CDS prices for Morgan Stanley and Goldman Sachs have really moved back to more normal trading levels, while Bank of America and Citigroup are down but still have a lot further to fall before anyone can say the coast is clear.

Comments

[User 96077:]

Interesting and insightful article. Thank you.

May 09 09:45 AM

[RiskReturnO...:]

The spread compression from investment grade companies have already been reflected into the price of equities (the market is somewhat efficient after all). On the other hand, for BBB and lower paper, the spread compression has not been reflected, so expect the next pop in equities to come from the next tier of companies. Just watch the price of JNK and HYG go up every day, but the price of the stocks have not moved much. Either JNK and HYG have to reverse and come back down, or the equities will make a VERY big move. For list of holding, you can go to the ETF websites. Some financial examples include: CIT, SLM, etc.

May 09 11:41 AM

[RiskReturnO...:]

The spread compression from investment grade companies have already been reflected into the price of equities (the market is somewhat efficient after all). On the other hand, for BBB and lower paper, the spread compression has not been reflected, so expect the next pop in equities to come from the next tier of companies. Just watch the price of JNK and HYG go up every day, but the price of the stocks have not moved much. Either JNK and HYG have to reverse and come back down, or the equities will make a VERY big move. For list of holding, you can go to the ETF websites. Some financial examples include: CIT, SLM, etc.

May 09 11:41 AM

[RiskReturnO...:]

The spread compression from investment grade companies have already been reflected into the price of equities (the market is somewhat efficient after all). On the other hand, for BBB and lower paper, the spread compression has not been reflected, so expect the next pop in equities to come from the next tier of companies. Just watch the price of JNK and HYG go up every day, but the price of the stocks have not moved much. Either JNK and HYG have to reverse and come back down, or the equities will make a VERY big move. For list of holding, you can go to the ETF websites. Some financial examples include: CIT, SLM, etc.

May 09 11:46 AM

[MarkitWacha:]

So, you could potentially arb out this by shorting the market and buying a junk


On May 09 11:41 AM RiskReturnOptimizer wrote:

> The spread compression from investment grade companies have already
> been reflected into the price of equities (the market is somewhat
> efficient after all). On the other hand, for BBB and lower paper,
> the spread compression has not been reflected, so expect the next
> pop in equities to come from the next tier of companies. Just watch
> the price of JNK and HYG go up every day, but the price of the stocks
> have not moved much. Either JNK and HYG have to reverse and come
> back down, or the equities will make a VERY big move. For list of
> holding, you can go to the ETF websites. Some financial examples
> include: CIT, SLM, etc.

May 09 01:57 PM

[Chkrazer:]

Thank you. Good article.

May 09 03:46 PM

[RiskReturnO...:]

That has been the winning trade for the past few weeks (long JNK, HYG, hedged with puts on few stocks). The concern that that once yield of JNK and HYG gets to "normal" level, than the underlying equities might "catch up", and the short equity trade would hurt quite a bit. On similar trade, I've written before about being long preferred shares / convertibles, short common stock -- great during March and much of April, but recent equity run is hurting on the short side. So, perhaps go lighter on the short side (3:1).


On May 09 01:57 PM MarkitWacha wrote:

> So, you could potentially arb out this by shorting the market and
> buying a junk

May 09 04:46 PM

[wholesalecd:]

In other words BUY Citigroup NOW before you get left in the dust.

Actually I would be buying any of the banks right now.

Once it gets going and the economy improves this level will not be repeated again.

JAY BOY BILLY

May 09 09:02 PM

[Market Sniper:]

Well, here is another take. If the BIS announces an increase in OTC Derivatives in a couple of weeks, a total financial collapse is guaranteed. Even the person who came up with the concept of CDSs recently announced that the instruments should be hung, drawn and quartered immediately, or words to that effect. CDSs are the spawn of the devil.

May 10 03:36 AM

[Ishortyou:]

the fall of LEHMAN!!!!!!!! almost send us to the stone age...if Paulson and company would have not allow the fall of Lehman we wouldnt be going through this current unnecessary turmoil, it would have been CHEAPER !! to bail out Lehman than bailing out the whole financial sector...dumb dumb dumb really...thank you Paulson for ruin our nation! ....the bolsheviks have learn this lesson very quick and they will not allow any damn bank to fail till the coming elections are over otherwise it would not look good in their image.

May 10 09:27 AM