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* The TED spread made a new YTD high at 49 bps, again signaling that risk in the banking system continues to rise. Until we see either stabilization or a reversal in this trend Financials investors should not assume the systemic risks are being properly addressed.

*Despite newly elected governments in Italy and Spain, credit default swaps for Eurozone countries mostly widened on Monday. Spanish and French swaps were particularly noteworthy widening by 8% and 12%

Margin Debt expanded in October to $283B, up from $262M in September.  The increase reflects the massive move in the market in that month, and reminds us yet again that the retail investor usually buys high and sells low. As a reminder, our analysis shows margin debt is highly cointegrated with the market over long periods of time, and importantly hit an important cycle peak in April 2011. We walk through this in greater detail below.

* Our macro quantitative model indicates that the short term (TRADE) downside/upside setup in the XLF is currently around 1 to 1 (2.3% downside vs. 2% upside).

 

Margin Debt in October

We publish NYSE Margin Debt every month as soon as it’s released. 

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. 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. In other words, the last few months’ 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 retraced back to +0.43 standard deviations in September, 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. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in October’s print of +0.78 standard deviations. But overall, this setup represents an ongoing material headwind for the market.  

One limitation of this series is that it is reported on a lag.  The chart shows data through October.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Margin Debt

 

Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Negative / 1 of 11 improved / 6 out of 11 worsened / 4 of 11 unchanged
  • Intermediate-term (MoM): Negative / 1 of 11 improved / 6 of 11 worsened / 4 of 11 unchanged
  • Long-term (150 DMA): Negative / 1 of 11 improved / 8 of 11 worsened / 2 of 11 unchanged

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Summary

1. US Financials CDS Monitor – Swaps widened for 26 of 27 major domestic financial company reference entities last week.   

Widened the most vs last week: RDN, MET, XL

Widened the least/ tightened the most vs last week: COF, UNM, MMC

Widened the most vs last month: GS, MS, RDN

Tightened the most vs last month: MBI, GNW, MMC

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - CDS  US

 

2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 39 of the 40 reference entities. The average widening was 8.1% and the median widening was 13.6%.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - CDS  Europe

 

3. European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 8% (+36 bps to 463) and French by 12% (+25 bps to 227).

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Sovereign CDS 1

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Sovereign CDS 2

 

4. High Yield (YTM) Monitor – High Yield rates rose 24 bps last week, ending the week at 8.06 versus 7.82 the prior week.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - High Yield LT

5. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 5 points last week, ending at 1587.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - LLI LT

 

6. TED Spread Monitor – The TED spread hit another YTD high rising 3.1 points last week. It ended the week at 48.8 versus last week’s print of 45.7. 

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - TED spread LT

7. Journal of Commerce Commodity Price Index – The JOC index rose 0.48 points, ending the week at -22.8 versus -23.3 the prior week.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - JOC LT

 8. Greek Yield Monitor – The 10-year yield on Greek debt fell 26 bps last week, ending the week at 2819 bps.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Gr Bond LT

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. Last week spreads widened, ending the week at 183 bps versus 172 bps the prior week.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - MCDX

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 rose 60 points, ending the week at 1895 versus 1835 the prior week.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - Baltic Dry Index

11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread tightened to 172 bps, 9 bps tighter than a week ago.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - 2 10

12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.3% upside to TRADE resistance and 2.0% downside to TRADE support.

MONDAY MORNING RISK MONITOR: TED SPREAD MAKES NEW HIGHS WHILE EU SOV DEBT FALLS FURTHER - XLF macro setup

Joshua Steiner, CFA

 

Allison Kaptur

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