Bad Credit

The big week is finally here, but before addressing the Fed tomorrow there's some unfinished business from last week that requires attention.  On the matter of Tom, Dick, and Harry, their true identities are:

Tom:   GDX times pi.   It's quite a base that it's trying to form, and if you buy it, you clearly know where you're wrong!



Dick is the Australia vs New Zealand two year swap spread.  While markets are understandably nervous on Australia given the goings-on in China, the domestic economy continues to chug along, thank you very much, apparently unobserved by anyone in the Northern Hemisphere.   The swap spread is at it highest level in more than two years, yet AUD/NZD has taken a bath recently and is back down towards very long term structural support.  Given the strong relationship between the two, Macro Man likes AUD/NZD here.



Harry:  Three month EUR/USD forward points divided by e.  Between the October and December ECB meetings, EUR/USD moved in lock-step with the forward points.  Since Eurogeddon, the forwards have largely come back, while the euro remains fairly close to its highs.    It's positioning, for sure, but nevertheless worth noting that the tangible reason that people were short EUR still remains.   The hopes and dreams of free Maybach Uber rides financed by unlimited ECB largesse will, sadly, remain unfulfilled.


And now, credit.   Friday's bloodbath may not have been the end, or even the beginning of the end, but at the very least it marks the end of the beginning.    There was clearly an element of capitulation in Friday's price action; not only did HYG and JNK melt down, but they did so on extraordinarily high volume.    Indeed, Friday's dollar amount traded in the two ETFs was easily a record, and more than double the volume of any trading day prior to last week.

Moreover, not only did both ETFs move to a discount to their NAVs, but in each case it was the largest discount of the year.   If that's not "just get me out" price action, well, Macro Man doesn't know what is.  And small wonder, too.  Macro Man calculated since-inception costs basis figures for the two ETFs using daily inflow/outflow data and assuming that on average the market is filled on the daily closing price.   For both HYG and JNK, the since-inception average purchase price is above the current stock price.

Of course, you buy high-yield credit for the, er, yield, so it's important to take dividends into account and look at total return.  Unfortunately, even doing that, just about anyone who's bought JNK since the beginning of 2013 is offside...



...and the same with HYG.



Even nastier, both ETFs have seen net inflows this year from the JBTFD crowd.   The average cost basis for 2015 buys in HYG is $88.83, versus a current price of $79.52.  There's an even worse profile in JNK, with an average 2015 cost basis of $38.87, versus a closing price of $33.69.

All of this is a fancy way of saying that people are selling because they're losing money....which you probably knew already.  Now, of course, is the time that all those concerns about market liquidity and the absence of market-making risk principals to intermediate between urgent sellers and not-so-urgent buyers come to the fore.

Thankfully, Dolores Umbridge has assured us that the financial system is safer thanks to all the regulations she's helped enact, which is comforting; not as comforting as not hemorrhaging money if there were someone to take the other side of your sell order, mind you, but still....take your blessings where you can.

And just for the record, let's just be clear that it is not the impeding Fed rate hike that's the cause of all of this kerfuffle in credit.   Obviously energy prices have played a big role via deteriorating fundamentals, but as discussed that's more of a supply story and a China story than a US financial conditions story.

No, from Macro Man's perch the market mechanism is the real scare story here.  The Volcker rule has eliminated principal market risk-taking in banks except for the Treasury market.  Of course, this raises the question:  if prop trading is bad, why is it permitted in the Treasury market, which from the government's perspective should be the holiest of holies?  On the other hand, if it is good and useful for ensuring a proper market mechanism in Treasuries, why should participants in other markets not be afforded the "luxury" of not getting screwed by slippage every time they try to transact?

Answers on a postcard can be addressed to

D. Umbridge, Ministry of Regulation, c/o Hogwarts School of Financial Remediation.

In the meantime, ponder the idea that there are still 19.6 million more shares of HYG and 41 million more of JNK than existed at the end of last year, and ask yourself what those holders are going to do in the coming weeks.   Then ponder on what professional holders of high yield and other credit will do after having gorged for the last several years only to see the wheels finally start to fall off.

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Anonymous
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December 14, 2015 at 7:34 AM ×

A central bank is buying equities on the European open today. I'll leave it to you to guess who. Enjoy.

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Eddie
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December 14, 2015 at 9:42 AM ×

Some more details on the inner workings of Third Point's "redemption" scheme:

Third Avenue CEO David Barse Departs

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Eddie
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December 14, 2015 at 11:11 AM ×

For good measure, some preemptive excuses of Dame Janet's mouthpiece:

Fed Officials Worry Interest Rates Will Go Up, Only to Come Back Down

"In short, the age of unconventional monetary policy begun by the 2007-09 financial crisis might not be ending."

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Booger
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December 14, 2015 at 11:14 AM ×

NG 1.82, looks very tempting for a long into fed day for a short term bounce.

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Anonymous
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December 14, 2015 at 11:35 AM ×

Another credit fund just liquidated.

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Macro Man
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December 14, 2015 at 12:39 PM ×

# Anon 7.34 Looks like it was just for the bloke's PA, doesn't it?

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abee crombie
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December 14, 2015 at 1:38 PM ×

Funny how all the guys talking about HY blow up, Gundlach, Gross etc manage HY funds as well. yes yield hogs are getting slaughtered here, as no one wants to reach for spread. But non commodity price dependent bonds are looking very attractive here assuming a recession isnt on the horizon. Anyways it all depends on commodity prices at this point.

NG is setting up for a great LT buy. Winter is delayed this year. So I guess retail will bring out the same excuse again why sales were much lower.

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washedup
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December 14, 2015 at 1:59 PM ×

abee - yes i can't disagree on NG - the summer 17 strip @around 2.50 could turn out to be quite a bargain for the patient.
MM put it best - feels like the end of the beginning for credit - the trend has kind of shown its hand though.

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AL
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December 14, 2015 at 2:33 PM ×

I am reducing the long held underweight in equities from 80% of the BM to 90% and probably will go like this into year end. Maybe a bit premature given the price action. Maybe a bit premature given the price action, but the idea is to go close to BM (95%) for the crossover into 2016 .... don't want to start with big relative bets.

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washedup
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December 14, 2015 at 2:59 PM ×

AL - how typical do u think that behavior would be this year? Isn't that sort of the premise behind santa rallies?

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Anonymous
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December 14, 2015 at 3:08 PM ×

Fed's PPT is in the mkt supporting US equities.

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AL
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December 14, 2015 at 3:18 PM ×

washedup ... it is probably kind of typical not to have huge relative bets on January 1st, for investors like me (i. e. long only and benchmarked for most of the clients). Problem is the starting point: I believe not too many were underweight, while probably most were (still are) mildly overweight equities and I woudln't be surprised that one of the sources of pressure in the market currently are exactly these accounts selling to get closer to BM.

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Anonymous
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December 14, 2015 at 3:20 PM ×

Central banks and HFT are great for markets. The SP500 is currently an oasis of calm...

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Anonymous
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December 14, 2015 at 5:20 PM ×

US indexes rallying heavily as Fed PPT buys equities to reverse day's loses.

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Nico G
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December 14, 2015 at 6:06 PM ×

you Anonymous posting about fantasy PPT and ghost CB supporting equities, your input here is zero

i suggest you change your way of thinking before it's too late. Haven't you noticed how price action has dramatically changed? Have you ever been through a bear market? yeah, the one where they sell every rally. you probably have no idea how much it hurts.

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Nico G
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December 14, 2015 at 6:11 PM ×

i don't remember who was buying European banks here but they are getting slaughtered - whether Spoos are finally catching down with everything else is still left for interpretation, but Europe is getting decimated.

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Anonymous
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December 14, 2015 at 6:38 PM ×

Dax back through Draghi's "do what we must" comments from Oct 22nd, catching up with the others. Will the holiday period come in time? It probably feels a long way off to some out there.

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Leftback
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December 14, 2015 at 8:47 PM ×

Quite interested in the prospect of a bit of Knife Catching™ but in Jeff Gundlach's words we are "not interested in things that are going down every day" - wise words, for the time being at least.

Sometimes the best way to play these situations is to grab a small bite or two of something using calls, so that one's losses are limited and defined, before one finally wades into the muck with the Kevlar gloves™ and body suit. High yield continues to be ugly but it's time to take out your pencil and identify the bargains. Assuming one has some lead in one's pencil, of course... you'll need that.

Nico we still have a tiny amount of SAN and BBVA (bought at Euro bond meltdown prices in 2011) and yes, they are being slaughtered again. Other than a pile of US fixed income we remain Hammock Investors™ here.

EoY rally is coming, but when? Let's ask La Paloma Blanca™ on Wednesday.

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Leftback
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December 14, 2015 at 9:02 PM ×

Apparently there haven't half been a load of dozy plonkas in the high yield space and now we are going to have to sit around and watch them all unloading their pants:

Lucidus Capital Liquidates HY Fund

There is never only one cockroach. Grab some popcorn, and hold the Kevlar for now.

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abee crombie
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December 14, 2015 at 9:55 PM ×

Lucidus was liquidating a long time before any of this Third Ave stuff came out. There returns were crap for the past 5 years. Not a big surprise.

But please sell more of your BX and other asset managers. I'd love to buy some at $20

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Anonymous
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December 14, 2015 at 11:36 PM ×

LB, end of year rally starts after ZEW. Through fomc and opex. We then forget about HY credit for the first few weeks of 2016. Equity futures liquidity thin with rollover

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Nico G
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December 15, 2015 at 5:46 AM ×

some observation from the Fly worth a look:

" stocks with market caps under $1 billion are down a median of 49% this year. And that strips out low volume crap, by inserting a volume filter of 500k per day...Conversely, stocks with caps above $1 billion are off by just 7%. When we apply a beta filter under 1, the loss lessens to just 2%.

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