Category Archives: Equities

Brexit – consequences for investors

BREXIT and the consequences for global investors

The markets (and pollsters) got the BREXIT all wrong last week and Britain did indeed decide to unshackle itself from increased Federalization – and an external Federalization at that. The magnitude of the exit vote surprised even the exit-vote camp, and global markets sharply turned south as investors were seen paring risk and ploughing into safe havens (Treasuries and the like). This was an expected reaction because markets had to pause and catch their breath from the unexpected turnout and assess the outcomes from a future independent UK. (In the days since, a good part of the risk-taking has resumed from the initial knee-jerk reaction)

While some reports may characterize the exit vote as being “anti-trade”, I feel it is more to do with dislike for Federalization and increased bureaucracy, especially that imposed from outside UK’s borders. Immigration was a contention, say others but that too dovetails into the Federalization argument since the Immigration decision was taken by the EU for all member countries. With that as a backdrop, the timing is two years for the UK to formally exit from the EU. A possible new UK Government is expected now that Cameron is stepping down. Along with that is the question of what exit agreements the EU and UK hammer out. It is possible that punitive actions may be taken by the EU to discourage other member nations with exit ambitions. Or it could be that the trade imbalance with Germany (positive for Germany) may dictate a softer, comradely stand.

In any case, we are talking political and trade uncertainty here and uncertainty stretched out in time – a combination that is unpalatable to markets. That should spell increased volatility in risk assets and a general favor towards risk-free assets, however rich they may be. Expect the dust to slowly settle as investors get comfortable with the tone from EU and the new UK Government and they assess the longer term winners and losers (sectors). But aside from this, what can further deepen the damage could be anti-establishment forces increasing in other EU countries as they take UK’s exit vote as a comfort tonic to rev up their anti-EU engines. The keyword therefore is volatility.


Brexit – Is it a big deal?

BREXIT – short for Britain Exiting the EU – has captured attention, for political and economic reasons. While the long-term effects of Britain staying or leaving the EU are debatable, the immediate attention has been Britons’ divided opinion casting a negative pall over the concept of EU itself. Britons, for the “exit from EU” camp, are asserting centuries-old style of British independence from the continent. They cite reasons of bureaucracy and central command that could stifle British flexibility. The anti-exit or “stay” camp on the other hand, point to loss of trade with the continent and possible economic isolation (and one that President Obama also warned against during his trip to the UK).


Again, while it is difficult to read the tea leaves to figure out long-term repercussions given the dynamic nature of global trade, the immediate bombshell has been the very questioning of EU as a safe mothership for member nations. Britain is still the fifth largest economy in the world and the EU would value its loss from its economic fold. But more importantly, this would open the door for similar-minded nations valuing their independence to think about a possible withdrawal. The snowballing of such an effect could spell disaster to the concept of a EU that still is not a nation with a united fiscal policy and government. Many weaker European nations are chafing at possible Greece-like reforms forced down to them from Brussels and Germany to solve bank problems and tax receipts. They may now take a cue from Britain and exit and devalue their currencies to solve their economic woes.


Thursday is the vote. And there will be immediate winners and losers. Exporters from Britain might benefit handsomely if Brexit happens and the pound is devalued. London, the financial center, could reel in benefits from increased volumes if Brexit does not happen. Right now, the odds seem slightly higher that Britain will continue to stay in the EU. But there is more riding on the Brexit rather than just the quaint notion of Britons asserting their literal and figurative independence from the mainland. This is more about a large economy that is still familiar worldwide firing across the bow of EU and heralding a larger dissent in the wings.

(BN) Fed Officials Saw Global Slowdown Among Risks to Outlook (1)

Low rates forever? Looks like a world of watered-down currencies globally, with investors chasing returns and not really creating organic growth anywhere within the G-8. Cannot end well.

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)

Blackstone’s Byron Wien Explains This Stock Market –

Blackstone’s Byron Wien Explains This Stock Market –

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.


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

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