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Credit Update: Equity Markets Headed Lower As Credit Swoons

Credit Watch with MJ the Credit Guru: 7/11 9:46am

Credit points to more equity market weakness…while the lack of an equity market catastrophe appears to be keeping credit from falling off of a cliff. Credit is 4bps wider on the day…We find it hard to believe that the equity markets have reached their intraday lows….sorry for the bad news.

7/11  8:14:09

It appears as if credit traders are playing the widening momentum rather than stepping in front of this one way freight train. Credit has actually increased its amount of underperformance relative to equities since our 7:30am note. The CDX IG16 Index is almost another 1bps wider even though S&P futures have remained relatively steady.

 

 

Credit’s reaction to US and European sovereign worries is understandable given the risk/return relationship of Credit. (Spreads can widen much more than they can tighten on good news.) Given the relationship between credit and equity markets since the fall of 2007, we expect equity markets (S&P) are biased to sell-off into the -30pt range and the VIX is likely to spike.

At:  7/11  7:31:00

 

 

 

The CDX IG16 Index is +3 5/8bps wider this morning…that is a pretty large move for the index and is likely to spill over into the VIX as well as continue to pressure equity futures wider. To put the widening move in perspective, this large a move in the IG16 Index would indicate that S&P equity futures are likely to slide another 12-15pts to -30+ range if credit markets do not experience a recovery rally or the markets decouple.

Looking ahead: The IG16 Index is trading in the mid 95 3/4 range and we believe that it is still more likely that the index will pressure the 100bps demarcation line before trading meaningful below 90bps. High levels of credit spread volatility almost always favor the credit shorts and credit volatility remains uncomfortably high in our opinion.

As we have been saying throughout the recent Greek recovery rally, we expect credit traders will continue to aggressively range trade and that pushes wider in the index would be met with pilling on that likely cause negative equity market sentiment to build and send the VIX higher. In our opinion, the reexamining of the sovereign credit crisis and the inability to deal with the US debt limit are simply the sparks that are likely to fuel today’s weakness.