Is The "Risk-on" / "Risk-off" Trade Starting To Fall Apart?
From Peter Tchir of TF Market Advisors
Is The "Risk-on" / "Risk-off" Trade Starting To Fall Apart?
For awhile now, the market has loved to talk about risk-on or risk-off. Occasionally a few outliers exist, but by and large that pattern of everything risky up or down together has been holding. It felt like that is potentially starting to fall apart this week.
The first thing that caught my eye, was the difference in performance between credit and stocks. The CDX IG16 index was actually wider on the week. It closed at 123 the prior week and finished this week at 126.25. That is not a major move, but is in sharp contrast to the SPX which was up 4.7% on the week.
That relative out performance of stocks left many investors scratching their heads. For all the talk about "credit" leading stocks, or warning signs in the credit markets, they were all ignored this week, at least in U.S. Stocks.
Another thing I found interesting was the CDX HY16 index was down on the week. About -.75%, so not material, but interesting since HYG, was actually up just over 0.5%. Was the cash market better than the CDS market? Well, the NAV of HYG was down almost -1% on the week. Why did HYG buck the trend? Is the fact that it is a stock means it has buyers that don't exist in the actual world of high yield bonds or CDS? Something about this move concerns me. CDS and NAV don't always move the same direction, but the moves in both of those markets match this past week, and seem to match the performance that I actually saw in the junk bond market reasonably well. That is consistent and implies a functioning market. Why is HYG doing better? That doesn't make sense to me.
Since Wednesday, many of the core risk-on/risk-off relationships have broken down. The Euro was up 0.6% ther past 2 days. QQQ's were up 0.8%. TLT was up 2% in that time. Those moves are all consistent with the risk on trade. But Dax was down -2.5% in that time and the Euro Stoxx 50 was -2.2%. Gold was actually up 2.3%. LQD underperformed treasuries, indicating spread widening. Italian 10 year bonds were down a quarter point, and Greek bonds rallied a tiny bit, but only after big losses, and the 2 year hitting new lows early in the week. SPX was barely down in the 2 days, but clearly didn't follow the Jobless QQQ rise, and that was with BAC up over 10%. Oil, which has been confusing, remained so, with prices pretty stable on the week.
Some of this data is impacted by various closing times of markets but there is a clear divergence between credit and stocks, and U.S. Stocks in particular. Anyone watching the intraday moves can't help but notice that not everything is moving at once like it had. Is this a function of hedges being unwound or that each market is trading based solely on the maximum pain it is inflicting on its participants? I really couldn't shake the feeling that by the end of the week, the only asset class trading like it was "risk-on" mode, was the U.S. Stock market. How long can that last?
There is a lot of data coming out here and in Europe. That should drive the markets. Any residual follow through from Jackson Hole seems like it will weigh on the market rather than propel it, as neither Trichet nor Lagarde provided any immediate stimulus, and if anything, followed in Bernanke's path of a little bit of finger pointing and calling for others to do their job. I am sure Obama has cooked up a plan for jobs and housing, but I really find it hard to believe that the plans will be particularly credible, or that Wall Street will bet that he can get them implemented.
Good luck, and hopefully the simplicity of risk-on or risk-off will return, otherwise I suspect this will get very messy as so many trading strategies have depended on it.
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It's risky to be "risk on"
Some of the dominos are falling
Before 2011, playing with monetary stimulus, fiscal stimulus, bailouts, bank rescues and sovereign rescues (all of which spell Money Printing) seemed rational, sane and proper.
Now, it's being viewed as playing with matches at a gas station. That's because the world and the US economy have already experienced first hand what can go wrong. And there's increasing suspicion that what we've seen so far is just the appetizer course.
That's why the Fed had that 'boxed in' impotence feeling at Jackson Hole. It was that conference that was a non-event, not Hurricane Irene. And that's why the Fed is playing hot potato, throwing responsibility for more stimulus to the politicians and Obama. And in Euroland, it's all 1000x worse with all the proliferating rescues melting like drippy candles into a gooey mess. Can you spell 'contagion'?
The stakes just keep getting higher and higher. Protection, caution and safety are the order of the day. The storm clouds may have passed over NYC, but the figurative ones are getting thicker by the minute
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Another thing I found interesting was the CDX HY16 index was down on the week. About -.75%, so not material, but interesting since HYG, was actually up just over 0.5%.
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HY bonds have gotten smacked in August, but this -0.75% week should not be evaluated in raw fashion. The smackage has been due to massive redemptions, and this past week they stopped. HY didn't track equities, but they calmed the fuck down. This matters a great deal. Calm HY pays big dollars in monthly payout. It's the up bias on total performance.
HYG is traded intra-minute and it's hard to find an update to its index intra-minute. The poster has this right about its buyer universe being profoundly different from general HY instruments' buyer universe. An examination of HYG over a longer multi week period finds that it does regress to the HY mean. So there's not much to be learned from a 1 week HYG move departing from HY as a whole.
HY bonds, in general, are throwing off monthly money at a 3+% advantage over IG bonds. This big volatility August is going to end and that 3% advantage will re-assert itself as people search for "safe monthly income/yield". HY funds are flat YTD and the S&P is down 7ish%, mostly from that monthly payout.
This will be seen and HY spreads will close.