Key Callouts:
* Interbank risk continues to recede. The Euriobor/OIS spread, our preferred measure of systemic risk in the banking industry, tightened 5 bps last week. This is a bullish input in our model. See our note from Friday quantifying the impact of the change in Euribor/OIS on the stock prices of C, BAC, JPM, GS & MS. A similar trend occurring in the TED spread, which fell by 2 basis points to 50 bps last week. Receding interbank risk both in Europe and the US means reflating the discount in the US global banks.
*Bank CDS in both the US and Europe tightened last week.
*European sovereign swaps were mostly tighter. However, Portugal has gone parabolic, widening 15% last week to an all-time high. It's interesting to observe the reduced correlations. In 4Q11 all swaps and equities generally moved together. Now we're seeing Portugal blast off, while other PIIGS countries and the European and US banks are tightening.
*The MCDX measure of municipal default risk continued to fall sharply week over week.
*Quantitative view - Out macro quantitative model suggest that on a short term duration (TRADE), there is slightly more upside than downside in the XLF (0.4% downside vs 0.6% upside)
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 8 of 12 improved / 1 out of 12 worsened / 3 of 12 unchanged
• Intermediate-term(WoW): Positive / 9 of 12 improved / 2 out of 12 worsened / 1 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 widened for 16 of 27 major domestic financial company reference entities last week.
Widened the most WoW: CB, MTG, PRU
Tightened the most WoW: BAC, MS, GS
Widened the most/ tightened the least MoM: MTG, RDN, CB
Tightened the most MoM: BAC, MS, AIG
2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 34 of the 40 reference entities. The average tightening was 2.3% and the median tightening was 9.4%.
3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. Italian sovereign swaps tightened by 6.8% (-31 bps to 426 ) while Portuguese sovereign swaps widened by 15.2% (193 bps to 1462).
4. High Yield (YTM) Monitor – High Yield rates fell 11.0 bps last week, ending the week at 7.94 versus 8.05 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 13 points last week, ending at 1626.
6. TED Spread Monitor – The TED spread fell 2.0 points last week, ending the week at 50 this week versus last week’s print of 52.
7. Journal of Commerce Commodity Price Index – The JOC index rose 4.7 points, ending the week at -9.38 versus -14.0 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 from last Monday to 77 bps today.
9. ECB Liquidity Recourse to the Deposit Facility– The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
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 , ending the week at 128 bps versus 134 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 136 points, ending the week at 726 versus 862 the prior week.
12. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins. Last week the 2-10 spread tightened to 168 bps, 11 bps tighter 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 0.4% downside to TRADE support.
NYSE Margin Debt - December
We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 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 last 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 2011. 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 +0.53 standard deviations in November, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in November and December's print of +0.55 and +0.53 standard deviations. Overall, however, this setup represents a headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through December.
Joshua Steiner, CFA
Allison Kaptur
Robert Belsky
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