Monthly Archives: December 2013

Credit update December 23, 2013

The QE taper came finally, to the tune of $10 billion, but the market paid no heed to it – enamored as it was by a far bigger headline from the Fed: that interest rates were to stay low for a longer period than previous estimates. Stocks rallied strongly on this note: that the QE taper was minimal but low rates would help the economy and drive growth rates faster. In other words, the market is saying it does not need the crutches from QE as much as it needs the low interest rates to help rev up all cylinders. And this is probably philosophically in tune with why the QE taper is happening in the first place: that the economy is past the risks of downturns and is on a growth trajectory.

In high yield fund flows, Lipper reported that inflows were close to $3 billion year to date, with ETF inflows comprising the majority. Last year, inflows were closer to $21 billion with ETFs holding a smaller share. This resonates with a desire for total-return-ers (whether retail or institutional) to relocate into equity territory for greater returns whereas “yield seekers” like insurance companies and pension funds have taken up the baton and have helped high yield stay tight. In 2014, we may see more of this behavior as conservative investors, chagrined at their non-participation in 25%-plus returning equity markets, rush to make amends and vacate their places to institutional yield seekers.

In EM news, China was down a little from needing an “emergency” infusion. Central bankers are slow on infusion triggers as they seek to clean up their internal act even as they propel the country for a stronger domestic economy, away from a purely export-oriented model. The country is still poised for growth and has targeted 7.5% which, though a lower headline, now works off a larger base (2nd largest global economy).

Spreads: Investment grade +65 bps over swaps (-4 bps tighter week over week)
High yield – 5.6% yield to worst (unchanged week over week)

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Credit update December 16, 2013

Stocks declined over the week on QE taper fears; the unemployment numbers are coming closer to the mark and the taper “hint” is seen coming this month. Although inflation is still benign and could allow for continuation of the program, the continued positive numbers on jobs and manufacturing are pushing decision-making closer to a “taper”.

Stocks are ready to make a transition from outright risk support from the Fed to a growth-oriented model; it needs the finality of the taper to digest this fact and move ahead. We have had knee-jerk reactions to a taper announcement in mid-year and hopefully this time, there will be a more-mature acceptance of the taper and its ramifications. After some 40% return in the S&P since August 2011, fueled in a good chunk by the QE programs, some sort of sanity viz. correction needs to happen before the growth story ignites the next cycle of stock performance. Because after all, QE taper means growth is here and the Fed can take its foot off the gas pedal.

High Yield ended the week unchanged and is holding onto a 7% YTD return. If it continues this performance in 2014, it will look good vs. stocks (consensus 10% return for 2014) given its coupon income and being higher up in the cap structure. In credit news, APC took a large hit as a judge ruled that KMG is liable to $5-14 billion of liabilities transferred to Tronox. 30-yr paper widened as much as +25 bps; meanwhile, the stock was down as much as 10 points. Since the credit is highly levered, a downgrade to high yield is not out of the question. Also, AIG reached a deal with AER (AerCap) to sell ILFC, after an earlier deal (not with AER) had fallen through.

Spreads:

Investment grade +69 bps over swaps (unchanged week over week)

High yield – 5.6% yield to worst (unchanged week over week)

Market action Dec 11, 2013

Seems like a day of profit-taking; everything is in the red: stocks, bonds, credit, gold, oil. Oh yeah, yen is up but that’s beside the point

Blackstone’s Byron Wien Explains This Stock Market – Barrons.com

Blackstone’s Byron Wien Explains This Stock Market – Barrons.com.

What is a “locked” market?

A “locked” market is trader parlance where there is no difference between a “bid” and an “offer”. Most securities trade at a spread, which is the difference between a “bid” and an “offer”, to enable a market-maker to earn the difference for engaging in the transaction. Naturally then, “bids” are lower than “offers” – in terms of price – to enable a dealer or market maker to buy a security at the “bid” price and sell it immediately at the “offer” price. The more liquid the market, it follows that the difference between the “bid” and the “offer” would shrink to reflect the lower risk of “carrying” a security past the market-maker’s bid, and before it is almost instantaneously sold. Therefore, it is common to see shrinking spreads between “bids” and “offers” in Treasury securities, large cap equities and the like. Similarly, larger spreads are common in riskier, less-liquid securities like high yield, distressed etc.

The ultimate shrinkage of spreads to zero is reflected in a “locked” market, where the “bid” and “offer” level is identical. “Locked” markets, by their very definition, are temporary because there is always a “spread”– or cost to make a market– regardless of whether the “spread” reflects risk or pays for fixed costs (like rent or electricity) or variable costs like tickets or electronic trails. A “spread” needs to exist purely to compensate market-makers for these costs, and to earn a profit. Also; more interestingly, “locked” markets can happen anywhere, in liquid markets like AA paper and even in riskier, illiquid sectors like EM or high yield.

The question then becomes: why would a market-maker offer a “locked” market? The answer is: to right-size his inventory, or position to a desired level. For example, dealer A is too long on some bank paper–say the 2s of 2015 issued by “Best Farmers Bank–and wishes to downsize that position by half. Let’s say the “Best Farmer’s” trade at 100-100.1 in price (bid-offer). Dealer A would “lock” himself at the bid side (100) or even slightly lower, like 99.99. At this price–say 100–he is willing to buy more “Best Farmer’s” or sell. He is now the cheapest “offer” on the security, and he should naturally be engaged to sell this paper, bringing his inventory naturally down to his desired level. But alternately, he may be engaged to buy more of this paper (not his desired direction); but even in this case, he should be able to unload this new paper back at 100 since other dealers are bidding similarly in the market.

In a reverse of the above, let’s say Dealer B is short these “Best Farmer’s” and is nervous about his shortage and wants to cover his position. He would “lock” himself at the “offer” side (100.1) and thus become the “best” bid for the paper, thereby covering his shortage.

So then, this begs the question: why can’t dealers just improve their bids or offers since that should get them the same result, given the superior levels? Well, we then come to the final appeal of “locked” market- advertising! When a “locked” market is broadcast, participants stop everything to notice the “locked” market. It is rare, and an opportunity to trade at the best levels (depending on the counter position), and it signals whether the dealer is long or short that security. In short, a lot of information travels in a “lock” and a lot more eyeballs are observing the “lock” than they are observing regular markets. This market attention and higher probable execution is the main reason why a dealer “locks” himself.

Credit update December 9, 2013

Stocks closed the week mostly unchanged. Although pundits are hailing a positive December to round out the year, QE taper has been the keyword as positive economic news continues to flow in, creating uneasiness on QE largesse. Also, with the large gains, profit-takers are stepping in to clock in their gains for the year, in preparation for the taxman. Credit markets were sitting on the sidelines, with high yield slightly tighter in spread but unchanged in yield. And investment-grade seems destined to have a negative return for the year (close to -2%) unless spreads (already at the lows) miraculously rally some 30 bps.

In credit news, Microsoft raised close to $8 billion in investment-grade offerings, ostensibly to buy back equity, a trend we have seen in the last two years (of increasing EPS either through buybacks or cost-cutting). Interestingly, this Microsoft debt offering was evenly split between $ and Euro, reflecting that European debt markets are as healthy.

In other news, JC Penney (JCP) has mostly been hammered down since the management upheaval (Ron Johnson ejected and replaced by Ullman) but the paper did rally a bit on the heels of better holiday sales (Black Friday etc.) but the paper remains yieldy (north of 9.5% yield on the benchmark 10 year). The stock ($8) has been mostly up from the lows ($6) set during its liquidity crisis (and the subsequent stock dilution), and the firm has managed to vault over the lower hurdles set for retail sales performance.

Spreads:

Investment grade +69 bps over swaps (unchanged week over week)

High yield – 5.6% yield to worst (unchanged week over week)

What is a black swan?

Fixed Income Academy: We Speak Bond, Do You? | Municipal Finance Today.