* The Euribor/OIS Spread, our preferred measure of systemic risk in the banking industry, tightened 5 bps last week. This is a strong bullish signal in our model. A similar trend has emerged in the TED spread, which fell by 3 basis points to 52 bps last week. Upward momentum in the TED spread is now definitively reversing. These trends are strongly positive for banking stocks as they reflate the existing European crisis discount.
* Bank CDS in the US and Europe tightened significantly. US moneycenters and large brokers saw declines of 10-15%, while major European institutions saw CDS fall 20% or more.
* European sovereign swaps mostly tightened over last week, except Portugal CDS, which widened 13% to an all-time high.
* The MCDX measure of municipal default risk fell sharply week over week.
* The ECB Liquidity Recourse to the Deposit Facility made a cycle low on Wednesday at a much higher level than typical cycle lows before beginning to rise again.
* Quantitative Downside - Our macro quantitative model indicates that on a short term duration (TRADE), there is slightly more downside risk in the XLF (2.1% downside vs. 0.6% upside).
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 5 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Negative / 0 of 12 improved / 9 out of 12 worsened / 3 of 12 unchanged
1. US Financials CDS Monitor – Swaps tightened for 24 of 27 major domestic financial company reference entities last week.
Tightened the most WoW: AIG, GS, MS
Widened the most WoW: MTG, RDN, AGO
Tightened the most MoM: AIG, BAC, MS
Widened the most/ tightened the least MoM: MTG, RDN, GNW
2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 39 of the 40 reference entities. The average tightening was 9.1% and the median tightening was 16.8%.
3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. French sovereign swaps tightened by 18.0% (-40 bps to 181 ) and Portuguese sovereign swaps widened by 13.4% (150 bps to 1269).
4. High Yield (YTM) Monitor – High Yield rates fell 7.0 bps last week, ending the week at 8.05 versus 8.12 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 8 points last week, ending at 1613.
6. TED Spread Monitor – The TED spread fell 2.7 points last week, ending the week at 52 this week versus last week’s print of 54.7.
7. Journal of Commerce Commodity Price Index – The JOC index rose 3.0 points, ending the week at -14.04 versus -17.0 the prior week.
8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 5 bps to 82 bps.
9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. The ECB pays lower rates than the market, so an increase in this metric demonstrates increased perceived counterparty risk and liquidity hoarding. The series made a higher low on Wednesday of last week but rose again to end the week at 492 billion euros.
10. 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 again, ending the week at 134 bps versus 142 bps the prior week.
11. 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 fell 191 points, ending the week at 862, the lowest level in at least four years.
12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 179 bps, 15 bps wider than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 2.1% downside to TRADE support.
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 and November’s print of +0.78 and +0.55 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 November.
Joshua Steiner, CFA
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