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* The TED spread made a new YTD high at 53.3 bps, indicating risk in the banking system continues to rise. We consider the TED spread to be a more sober reflection of systemic risk in the banking system. This is a strong cautionary note amid widespread equity gains.
* Credit default swaps for Eurozone countries mostly tightened on Monday. Spanish swaps were particularly noteworthy, tightening 23% compared to the prior week.
* Credit default swaps for American financial companies tightened 20% or more across the board (RDN, MTG, AGO the only exceptions).
* The Markit MCDX, a measure of municipal credit default swaps, tightened 20 bps to 193 bps from 173 bps in the prior week.
* The high yield corporate bond index saw a 50 bps increase in yields.
* Our macro quantitative model indicates that in the short term (TRADE), there is currently around 1.5 times more upside than downside in the XLF (1.5% downside vs. 2.3% upside).
Financial Risk Monitor Summary (Across 3 Durations):
- Short-term (WoW): Positive / 6 of 11 improved / 3 out of 11 worsened / 2 of 11 unchanged
- Intermediate-term (MoM): Negative / 1 of 11 improved / 5 of 11 worsened / 5 of 11 unchanged
- Long-term (150 DMA): Negative / 1 of 11 improved / 8 of 11 worsened / 2 of 11 unchanged
1. US Financials CDS Monitor – Swaps tightened for 26 of 27 major domestic financial company reference entities last week.
Tightened the most vs last week: GS, ACE, XL
Tightened the Least/ widened the most vs last week: MTG, RDN, AGO
Tightened the most vs last month: COF, ACE, MMC
Widened the most vs last month: BAC, SLM, RDN
2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 35 of the 40 reference entities. The average tightening was 9.2% and the median tightening was 22.6%.
3. European Sovereign CDS – European sovereign swaps tightened last week. Spanish sovereign swaps tightened by 23% (-108 bps to 360.5) and French by 21% (-49 bps to 185).
4. High Yield (YTM) Monitor – High Yield rates rose 50 bps last week, ending the week at 8.95 versus 8.45 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 4 points last week, ending at 1576.
6. TED Spread Monitor – The TED spread rose 3 points last week, ending the week at 53.3, another new YTD high.
7. Journal of Commerce Commodity Price Index – The JOC index rose 3 points, ending the week at -21.19 versus -24.16 the prior week.
8. Greek Yield Monitor – In contrast to improvement across the rest of European sovereigns, the 10-year yield on Greek debt rose 72 bps last week, ending the week at 3059 bps.
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 tightened, ending the week at 173 bps versus 193 bps the prior week.
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 59 points, ending the week at 1866 versus 1807 the prior week.
11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 178 bps, 8 bps wider than a week ago.
12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.5% upside to TRADE resistance and 2.3% downside to TRADE support.
Margin Debt in October
We publish NYSE Margin Debt every month when it’s released.
NYSE Margin debt hit its post-2007 peak in April of this year at $320.7 billion. 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 a material headwind for the market.
One limitation of this series is that it is reported on a lag. The chart shows data through October.
Joshua Steiner, CFA
Allison Kaptur
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