When It Snows In Buffalo, Get The Hell Out Of The Office

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If you strip out all the bad stuff, the picture looks pretty good.

Don't worry about defaults.

And make sure you're the hero that stays at the office until there's two feet of snow on the ground.

The following is based on a true Heisenberg story...

It was about noon and I was sitting in my old office on the 15th floor near Madison Square. It had started to snow about an hour earlier and it was getting worse seemingly by the minute.

It hadn't been a good morning. I woke up late - the product of a pint of this local gin they sell at Grand Central for something ridiculous like $45. I missed my usual train and by the time I finished my elaborate morning routine, I was about to miss the next one. It was winter, but in my rush I managed to forget my peacoat. I had on a wool suit so I figured I'd be alright.

The thing about snow in New York is it's a fact of life and when it comes to determining when you need to bail out of the office in order to make sure you get home, it's a delicate calculus. On the one hand, you don't ever want to be the guy that calls it a day at the first sign of flurries. On the other hand, you don't want to be the brazen idiot who is determined to outlast everyone in the building at the expense of your commute (otherwise, you might end up at the Grand Hyatt for the night).

This particular storm was telegraphed. Buffalo was already blanketed and it was clearly coming our way, but Buffalo is Buffalo. If they've got 18 inches we may get 5 (or less) and who wants to take their work cues from the weather in Buffalo anyway?

Still I finally left at something like 2. It was far, far too late.

By the time I got off the train at Westchester (where I was living at the time), there was something like eight inches on the ground and it was getting materially worse. I called every cab company I knew and this was basically the answer I got:

("Cabs? Oh yeah, we've got four or five people out there. They got us working in shifts. Cabs! hahaha")

Ok, so it was time to take the bus. Only the bus didn't run quite to where I needed to go. So they dropped me off at another bus stop in Yonkers. So there Heisenberg was, no peacoat, in the middle of Yonkers, at a bus stop, in 10 inches of snow and counting. I waited for that second bus and it never came. So I walked. All. The. Way. Home.

I walk in the lobby - my $685 Prada monk straps ruined - and felt like Steve Martin in Planes, Trains, and Automobiles at the car rental desk (can't embed that clip for language).

So let me show you, in one chart, why this is relevant for markets:

(Chart: Goldman)

Now here's the color:

As shown by Exhibit 4, the combined 12-month trailing default rate in the Energy and Metals and Mining sectors using monthly-refreshed cohorts continue to make new highs to 24.9% from 21.9% in the previous month. For the broader HY market, the 12-month trailing default rate also moved higher, in the vicinity of 5%. But ex-Energy and Metals and Mining, the HY default rate remains close to its post-crisis lows, at 1.9%. As we discussed a few weeks ago, we maintain the view that the spillover from Energy defaults into the broader HY universe should remain contained.

That is laughable for any number of reasons that should be very obvious to you as an investor.

Now first of all, they're using the old "if you strip out all the bad stuff, the picture looks good" argument.

But second, look at the red and blue lines! No contagion?! They're moving in lockstep. Defaults for HY (NYSEARCA:HYG) as a whole are moving up in synch with defaults in HY energy. Sure the broader rate is much, much lower (lhs), but the correlation is about as close to perfect as you can get.

I mean you can exclude maybe one sector, right? But they've effectively excluded three: energy, metals, and mining. How many sectors have to be excluded in order to make the numbers look good before this becomes an absurd exercise? I mean, do we just keep excluding the sectors where the defaults are every time they spike?

It's nonsense. It's like buying the SPY, seeing it fall, and then having the pros tell you "don't worry about it, if you exclude all the losers, you'd be up." That's a damn tautology. Of course you'll be up if you exclude every name that's down. What kind of sense does it make to employ that logic?

And yet look at this:

(Chart: Goldman)

Here's another way to look at it:

How in the world can those both be going up at the same time?

Finally, here's the energy default rate tracker from Goldman:

(Chart: Goldman)

Coming full circle, I'm going to use the exact same numbers from the first graph I presented to tie this all together so you can see I'm not just telling stories for the sake of telling stories.

If it snows 24.9 inches in Buffalo and you don't see any evidence that that snowfall is related to the 4.9 inches it snowed in New York (i.e. "no contagion"), then you're going to be out of luck when it snows 50 inches in upstate New York.

Apply that to high yield.

As always...trade accordingly.

PS: Whatever you do, don't get stuck in Yonkers with no peacoat.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.