Daily Commentary

Spreads are rallying again this morning on top of yesterday's strong rally.  Credit investors do not seem that concerned over the alleged DCX filing, bank stress tests or swine flu.  They are largely focused on extremely strong technical demand, a dropping Vix, normalizing credit curves, firm swap spreads and a shrinking negative basis (cash bonds outperforming CDS).

Most notable this morning is the inaugural US dollar corporate bond issue for Nokia.  They are bringing a 10 and 30yr bond to the market in the ~250-275bps range (over US treasuries).  Compare that to Motorola which trades ~660bps.  Bear in mind that Motorola is barely investment grade while Nokia has a strong single A rating from the agencies.

I'm surprised there is not more chatter about the potential FASB ruling on off balance sheet financing.  This could eventually bring billions of dollars of obligations back onto (already weak) bank balance sheets.  There's not much detail here yet but expect this to put pressure on bank spreads.

In a sign that sentiment seems much better, the Whistlejacket SIV liquidation occurred and it went fairly smoothly.  This was a notable and large investment vehicle that held ~$7B in assets (primarily structure product) when it was declared insolvent in February 2008.  Suffice it to say that this would not have occurred at all, let alone so quietly, unless confidence and demand were deemed strong enough.  

Eric Beinstein's excellent research group at JPMorgan shows that investment grade credit spreads are currently predicting that the S&P should be just above 1000 (1yr regression, Z score >2, R squared ~.8).  So, if you believe credit leads equities, it's time to buy stocks.

  

  

Daily commentary

The equity and credit markets are opening in slightly different directions this morning.  Credit spreads are slightly better as most credit investors realize employment figures are backward looking.  By nature, most credit investors are pessimists so it's only a 'bad' number if it's worse than expected.  I suspect, and hope, that credit investors are more focused on some consumer stabilization combined with sharp production cuts....or perhaps lending picking up in the UK.  

As I've mentioned previously, this recent easing by FASB of the mark-to-market accounting rules will help the financials.  Naively, I hope they reverse the ruling once this crisis passes as it's oft shelter for accounting shenanigans.

The FT's Lex, and others, have noted the irony in the recent interest of the banks in investing with the Fed's PPIP toxic asset program....yes, the same program that is allowing these very same banks to divest of their toxic assets.

The demand for credit continues.  Mutual fund flows into credit funds YTD are +$32B which is ~6.4% of AUM.  Contrast that with equity fund withdrawls of ~2% of AUM YTD.  Also, non traditional investors continue to express interest in buying distressed assets.   

Chapter 11 filings have been occurring at an increased pace.  To high grade investors, they largely pass unnoticed.  However, a recent filing by Idearc, has had wide, but not deep, repercussions.  Idearc is considered a 'successor' (in CDS terms) of Verizon.  Verizon was widely represented in the CDX investment grade credit indices.  Therefore, Idearc too had a tiny footprint in those same indices.  The notional amount for CDX indices 1 through 7 all must be adjusted slightly.  I note this as it serves as a reminder of the complexities of the credit derivatives market and how a seemingly unrelated event can have repurcussions in places you wouldn't expect.  For equity investors, imagine having to change the terms of the next 7 S&P futures contracts....systems, compliance, rich/cheap models....all have to change their inputs (albeit slightly).  The derivatives ops folks are busy today.    

Daily commentary

Spreads are opening largely unchanged this morning.  I attribute this to several factors.....mixed equities, Friday the 13th, a 6 OT college hoops game that ended ~1am, and a new 'upgraded' YAS function on Bloomberg; traders are creatures of habit and if one of their most popular functions changes, even slightly, expect a brief drop in liquidity as they complain and adapt.

I've long noted the correlation between the Vix and credit spreads.  It seems to be breaking down this year (spreads moving wider while the Vix drops).  While it could obviously revert back to 'normal' in either of 2 ways (spreads tighter/better or Vix higher [equities weaker]), I'm concerned the latter will occur given how rich the CDX index is versus it's intrinsics (~50bps).  Also, geopolitical headlines like North Korea shutting it's borders and the US shooting down an Iranian drone won't help the Vix.  

Take a look at these mutual fund flows YTD:

money markets +$56B

high grade bond funds +$25B

high yield bond funds +$7.4B

equity funds -$60B

Many cite mark-to-market accounting rules as one of the accelerants of this crisis.  FASB has said that they will soon issue 'guidance' on these rules.  As I've said before, if they ease these rules even slightly, we'll see an enormous rally.

Yes, shareholders have taken it on the chin this year to the delight of bondholders.  Now Jack Welch is kicking you while you're down uttering "shareholder value is the dumbest idea in the world."

FDIC is raising it's fees for it's guarantees so we're seeing a relative spurt in financials issuance ahead of this.

You saw retail sales....here's a quick snapshot of where 10yr bonds trade for a few names (remember, higher spreads indicate more yield but perceived weaker credits):

WMT +185

TGT +325

CVS +360

HD +490

LTD +1100

M +1200