Stock Market Strategy: Time to check the credit markets. As we have discussed previously, credit leads equity. So, with the equity market selloff of November causing Fin.TV anchors to hyperventilate an inspection of recent credit market action seems appropriate. Who better to perform the examination then our own credit Guru, MJ.
Bottom Line: While credit markets have weakened, the behavior appears more orderly and normal than the action witnessed during the April/May swoon. MJ expects the equity market selloff to be a buying opportunity not the beginning of something sinister….
Some Credit Market Facts… The CDX HY15 Index has surrendered nearly half its October rally, closing at $99.5 on Tuesday night. The HY15 Index had rallied from $96.75 (Sept 28) to 102.75 (Nov 5) before a wave of profit taking and negative sentiment caused it to weaken. The index lost $1.10 in Tuesday’s sell-off. These same concerns have caused high yield debt capital markets to weaken and forced some of the more “credit questionable” deals to be pulled from consideration…at least temporarily. Since November 5th, the CDX IG15 Index has widened nearly 10bps to 95.25bps from 85.75bps. The CDX IG15 5-year to 10-year credit curve has steepened about 2bps with the sell-off….
…European Bank CDS spreads, after ignoring the new “sovereign credit crisis,” have begun to widen. At this point, LOIS spreads have not been impacted by credit spread widening and banks do not appear ready to puke bonds due to funding concerns. It has been widely reported that the reason for the Eurobank CDS weakness is concern that governments may try to share the burden of taxpayer-funded bailouts with bondholders. This would mean that politicians have decided to abandon what has worked to do something that everybody knows is basically stupid….not likely. The argument also indicates that politicians would allow their sovereign debt to default instead of allowing a bank to default. Also a stupid decision and an unlikely event….
…Credit losses continue to decrease across all commonly securitized asset classes and the SEC has moved to undo some of the damage the recently passed FINREG legislature has imposed on the securitization market. Some members of Congress have publically stated – without much opposition at this point – that they intend to adjust the new law to allow for easier credit growth.
- Financial CDS spreads have widened, however credit curve action indicates markets are undergoing a re-pricing rather than being set up for an imminent crisis
…Taken as a whole, broad market consensus appears to indicate that European sovereign issues will fuel an imminent global equity and credit market sell-off. Market price actions also indicate that the majority of the sell-off could be concentrated in the financial sector and non-investment grade companies whose funding could come under pressure. Recent pressures also indicate that the ability of companies to engage in debt financed equity-enhanced transactions may have reached a cyclical peak….We do not believe the sell-off argument is a slam dunk. Why?
1) To begin with, the spring sell-off occurred during a period of time when FINREG debates were generating a large amount of uncertainty and other legislative “hearings” had caused Goldman Sachs’ credit curve to invert….While it is true bank CDS spreads have widened, BANK CREDIT CURVES HAVE STEEPENED OVER IN THE PAST WEEK. This would indicate that any sell-off is being interpreted as a simple change in valuation or a slight change in credit / market risk rather than a measurable increase in short term default risk. For the S&P500 to suffer a sell-off that retouches the 1050 range we believe that short-term bank default risk would need to skyrocket.
2) The spring’s Euro crisis generated a large amount of uncertainty because the market and politicians were forced to confront unique issues. Many investors appeared to believe that European politicians would make “stupid” decisions that would increase market uncertainty and cause the Euro currency to be abandoned. We believe the socialization of Eurozone sovereign risk will end up strengthening Europe’s commitment to the common currency even if it suffers from near-term volatility.
3) Another difference between this last spring and now is the Fed’s commitment to its QE programs and credit expansion. The Fed was in the process of withdrawing its exceptional support this past spring and fiscal “pump priming” was passing its prime with the reduction of the new home buyer credit.
4) Another major difference was the negative effect FINREG had on organic credit creation. The aggressiveness in which banks were willing to reengage the lending market was temporarily slowed this past spring. The recent loosening of consumer and commercial credit standards indicates that the US economy is better positioned to expand.
Precious Metals Outlook: The repeated increase in margin requirements along with typical Futures and Options expiration pressure has been able to slow the assent of Gold & Silver prices. This pause is healthy and necessary to maintain a strong bull market. In fact, the only real takeaway of note from the selloff is the remarkably shallow nature of the decline. If COMEX manipulation and expiration can’t break prices then something truly glorious may be afoot. The following ZeroHedge post offers further corroboration….
Surge Of Inexplicable After Hours Selling Takes Gold Volatility Index To All Time Low
In addition to the rout in the ES, VIX and GC which we pointed out earlier, there were some additional fireworks behind the scenes in today’s after hours session. The CBOE Gold Volatility Index, the ^GVZ plunged by the most in over a year, as the index hit an all time low of 15.92 without the underlying making much of a notable move. The most curious aspect of the trade was that the entire dump occured in the AH session. Many were left scratching their heads over what caused this monstrous unwind in long vol positions: was this the unwind of a massive long ES/short GC arb? We don’t know, although if rumors that a major fund is planning to stand for delivery of Dec gold turn out to be true, then obviously someone got confirmation today. Keep a close eye out on the GVZ. Should this price level persist on Monday, then the front futures contract will likely surge.
Disclosure: Positions: Long Precious Metals; Short Financials