One of the indicators to watch is the BofA subindex of IG financial bonds, which has dropped recently to post-Lehman wides (the recent move of Citi CDS to points up front is very indicative of the fear in the financial market). Curiously, as fear and loathing has spread among IG financials, the broad HY master index has continued to trade in the low 1,600s after peaking around 2,200, although on Tuesday and Wednesday it did drop lower and is currently in the mid 1,700s.
The paradox is that despite significant weakness in both higher and lower ranked asset classes (IG and equities), HY has been rock solid. The recent widening in IG Financials spreads puts the HY recovery at risk. This is even more evident from the next chart, which shows that HY credit spreads are among the narrowest in the credit space, with Single B spreads trading the tightest (73%) in terms of post-Lehman wides, compared to 98% for IG Financials. There is little chance of leveraged corporates surviving unscathed as the too big to fail companies are seeing a rapid increase in market risk. The HY correction is further justified when compared to the ongoing weakness in equities. In summary, the equity markets are down 20% YTD, while HY is up 2.5%. Over the last year, the correlation between the two markets has been 91%, which implies HY spreads are trading at 2.5x sigma deviation from implied levels. The gap can and will only close through either a strong rebound in equities or a 20% widening in HY spreads. Investors can decide which is more realistic.
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6 comments:
What is the best way to play this?
Agree with your thinking process, but what about the 3rd scenario: HY got hammered first last year and equities didn't get the memo until recently and just caught up while HY is stable. I'd rather take my cue from the average HY$ than the averagy equity$.
1.screen all B rated credits and short the rich outliers for outright
short.
2. short HY11 and go long IG11 DV01 neutral.
3. Short HY11 and buy equities 1:1 premise would be 20% convergence.
@ Peatey. i agree but i think memos are flying left and right these days. plus HY definitely has outperformed vs all other asset classes.
Is there any way for us plebs to do this via listed equities? Tyler, you are my new favorite news site. Thanks for all the great (and potent) info.
probably totally obvious point but maybe HY outperformance is due lack of financials in this index vs. IG/equity market damage which I'd guess was driven by widening/move lower in fins? totally agree on recovery assumptions being way to high. a default a day brings a lot of distressed assets the market....
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