This week's notable callouts include growing default risk for both US and EU financials and EU sovereigns. Further, we saw a new YTD high in the TED spread and a YTD low in our commodities proxy, the JOC Industrial CPI.
Margin Debt Falls in August - Don't Get Excited
NYSE Margin debt hit its post-2007 peak in April of this year at $320.7 billion. Let’s put things in context. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. There are two important takeaways. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period). We flagged this for the first time back in May of this year.
The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. For those unfamiliar, autocorrelation is simply a statistical term that means that trends tend to continue. In other words, the last few month’s change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which has retraced back to +0.64 standard deviations as of August, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. We’ve dropped 230 S&P handles in getting from +1.5 standard deviations to +0.64 standard deviations. Bear in mind there’s plenty of room for short/intermediate term reversals within this broader secular move. That said, this setup represents a material headwind for the market.
Financial Risk Monitor Summary (Across 3 Durations):
- Short-term (WoW): Positive / 1 of 11 improved / 7 out of 11 worsened / 3 of 11 unchanged
- Intermediate-term (MoM): Negative / 3 of 11 improved / 7 of 11 worsened / 1 of 11 unchanged
- Long-term (150 DMA): Negative / 2 of 11 improved / 7 of 11 worsened / 2 of 11 unchanged
1. US Financials CDS Monitor – Swaps widened across 27 of 28 major domestic financials last week. 19 of 28 companies saw their swaps widen compared to a month ago.
Widened the most vs last week: JPM, GS, MS
Tightened the most/Widened the least vs last week: COF, PMI, AGO
Widened the most vs last month: C, GS, MS
Tightened the most vs last month: PMI, CB, MMC
2. European Financials CDS Monitor – Bank swaps mostly widened in Europe last week. 39 of the 40 reference entities were wider week over week. The average widening was 11.3%, or 56 basis points, and the median widening was 23.4%
3. European Sovereign CDS – European sovereign swaps were mostly wider week over week, with only Spanish and Irish CDS spreads tightening. Most notably, the German sovereign CDS spread widened week over week by 26%. (Please note: Greek CDS is not shown in the chart because the data was not available. To gauge Greek credit risk, please refer to Greek bond yields below.)
4. High Yield (YTM) Monitor – High Yield rates rose 36 bps last week, ending at 8.20 versus 7.84 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 7 points last week, ending at 1534.
6. TED Spread Monitor – The TED spread made another new YTD high, ending the week at 36.5 versus 35.1 the prior week.
7. Journal of Commerce Commodity Price Index – After treading water for more than a month, the JOC index fell 9.9 points last week, ending the week at -14.3.
8. Greek Yield Monitor – The 10-year yield on Greek bonds rose 244 bps to end the week at 2,363 bps versus 2,119 bps the prior week.
9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. After bottoming in April, the index has been moving higher. Last Friday, spreads rose 26 bps and closed at 170 bps.
10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index hit its YTD high to ending the week 106 points higher at 1920.
11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 10-year yield fell to 1.84, pushing the 2-10 spread to 162 bps, 27 bps tighter than a week ago.
12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows the following: 5.6% upside to TRADE resistance, 2.5% downside to TRADE support.
Joshua Steiner, CFA