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Priced to Perfection?: Short MUB Trade Update

Conclusion: We think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. 

 

On Friday afternoon, Keith shorted the iShares National Municipal Bond Fund (ticker: MUB) in our Virtual Portfolio. In short, the fundamental thesis behind putting on this risk exposure is twofold: 

  1. From a long-term perspective, we think muni bond yields will rise amid our belief that U.S. interest rates are poised to continue making higher-lows; and
  2. The view that municipal issuers are experiencing a structural improvement in credit quality becomes decidedly less supportive going forward, posing a risk to muni bond prices as demand from the marginal investor slows. 

Looking at muni bond prices from an average yield to maturity perspective, the Bond Buyer U.S. 40 Municipal Bond Index is currently yields 4.65%, down from a cyclical peak of 5.95% in JAN ’11. Then, the story was growing fear of default and oversupply amid an expiration of the Build America Bond program. Since then, muni issuers (particularly on the State side) have shrugged off these credit concerns and continued to strengthen their balance sheets by dramatically reducing expenditures – even amid a sharp decline in federal support.

 

Priced to Perfection?: Short MUB Trade Update - 1

 

Priced to Perfection?: Short MUB Trade Update - 2

 

Now the question going forward is: “How much better can it get from a credit perspective?” While that doesn’t imply an immediate reduction in issuer credit quality, it does imply that fundamentals are unlikely to continue improving from what is known/priced in.  As the chart above highlights, States’ need for fiscal consolidation (i.e. the “hurdle” they must clear from a credit quality perspective) has declined to at least a four-year low in FY13 and is only ~1/4th  the size of the “hurdle” that was cleared in FY10.

 

Broken TRADE and TREND on our PRICE/VOLUME/VOLATILITY model, the MUB etf is signaling to us that tough questions are, at a minimum, starting to be asked in this traditionally-opaque market. Tough questions, such as: “If Obama wins reelection and the Democrats do better-than-expected in Congressional elections, will the tax exemption of muni bond income come under increased legislative scrutiny as Obama looks to secure additional funding for his ‘fair share’ initiative(s)?” do pose risk to the muni market from a price discovery perspective given that muni bond prices are just shy of their all-time peak (+14bps from YTM perspective).

 

Priced to Perfection?: Short MUB Trade Update - 3

 

Priced to Perfection?: Short MUB Trade Update - 4

 

All told, we think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. Muni bonds fit this framework like a glove; as such, we have decided to trade around muni bonds on the short side in our Virtual Portfolio.

 

Darius Dale

Senior Analyst


European Banking Monitor: Pain in Spain

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

Key Takeaways:


* Spain and its banks are getting worse. Spanish bank default swaps were materially wider week-over-week, rising an average 74 bps, or 18%. All six of Spain's major banks, on which swaps trade, are trading well over 300 bps (the "Lehman line"). Spanish Sovereign swaps widened by 27 bps to 427 bps. While most investors are focused on the rapid deterioration taking place in Portugal, we think Spain is the one to watch more closely. Will 2012 be a redux of 2011 on the Europe front, this time with Spain playing the lead role? Looking at sovereign and bank swaps of a country in conjunction has generally been a solid cointegrated risk measure.    

 

 

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 3 bps to 45 bps.

 

 European Banking Monitor: Pain in Spain - 11. euriibor

 

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.  The facility reached €785.4 Billion on 3/23.

 

European Banking Monitor: Pain in Spain - 11.  ecb facility

 

European Financials CDS Monitor – Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.6% and the median widening was 6.0%.

 

European Banking Monitor: Pain in Spain - 11. banks

 

Security Market Program – The ECB's secondary sovereign bond purchasing program purchased no sovereign paper in the week ended 3/23, for a second straight week of zero buying. February-to-date the Bank has purchased a mere €210 Million versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12. When questioned on the lack of buying over recent weeks, ECB President Draghi has only answered that the SMP is a non-standard measure that is “neither eternal nor infinite.” Clearly, with the some €1 Trillion injection of liquidity across the LTROs, the Bank is paring back buying and watching the results of sovereign bond auctions.

 

European Banking Monitor: Pain in Spain - 11. SMP

 

Matthew Hedrick

Senior Analyst


MACAU SLOWDOWN...FINALLY?

Lowering March GGR forecast to HK$23.5-24 billion.

 

 

Macau saw some deceleration this week with daily table revenues (ADTR) slowing to HK$664MM from HK$775MM last week and February’s ADTR of HK$776MM. With less than a week left in March, we are lowering our March forecast to HK$23.5-24BN, up 21% to 23% YoY.  As a reminder, March 2011 was the lowest hold month of year at just 2.66% (adjusting for direct play volume of ~6.6% or HK$4.5BN), so the comparisons are going to get tougher for the rest of the year.  While SCC should grow the market, 2011 also had the opening of Galaxy Macau, so the stimulation from new supply should be similar.  We have seen a YoY deceleration play out throughout the last 3 weeks where YoY went from 51% for the week ending 3/11, to 24% for the week ending 3/18, down to 17% this week.

 

The slowdown in the numbers was also reflected in lower volumes seen across the main gaming floors, so it’s unclear if all of the deceleration seen this week is simply due to changes in weekly hold rates.  Some have speculated that the slowdown could be partly due to some punters holding off their visits for the opening of Sands Cotai Central which is due to open just a few weeks from now.  However, the slowdown prior to new openings has been a little closer in historically.

 

MACAU SLOWDOWN...FINALLY? - MACAU 

 

In terms of market share, Galaxy was the biggest winner this week while WYNN was the biggest share donor.  We believe that the shift in market share was largely due to good luck at Galaxy and poor hold at Wynn.  MPEL’s weekly share was above its MTD trend, while LVS, MGM and SJM all were below MTD share. 

 

MACAU SLOWDOWN...FINALLY? - macau1


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

THE HBM: BEEF, WEN, BJRI

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Commodity Prices

 

Beef

 

A massive beef recall in Canada has crossed the border, leading the Seattle branch of a major food distributor to recall 16,800 pounds of ground-beef patties that may be contaminated with dangerous bacteria, according to the Seattle Times.

 

 

Commentary from CEO Keith McCullough

 

Top 3 Most Read (on Bloomberg terminal): #1 Spain Firewall #2 Asian Stocks Fall and #3 China Soft Landing – now we’re talking:

  1. JAPAN – clients want a “catalyst” in the Japanese Sov Debt Crisis – here’s mine: gravity. The Yen kicks off the week down -0.4% vs the USD (after Goldman said buy Yen Fri) and former exec director of the BOJ (Hirano, from 2002-2006) saying that Japan has “crossed the Rubicon with really desperate measures.”
  2. SPAIN – continued selling in Spanish stocks, down -1.8% to start the week and now down -5.1% for the YTD (vs Germany +18.6%) and Super Mario Monti wants “firewall.” It ain’t over, till its over folks.
  3. COPPER – the Doctor continues to look exactly like the slope of global growth, slowing. Copper now bearish TRADE and TAIL w/ big TRADE resistance overhead at $3.85/lb.

You’d think that after the worst week for Asian and European stocks in 2012, the bull would be back this morn. Nope.

 

KM

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: BEEF, WEN, BJRI - subsector 2

 

 

QUICK SERVICE

 

WEN: Wendy’s is claiming to be the first fast food company to back a new system that replaces the food processing industry standard practice of stunning chickens with electricity with a new low-atmospheric pressure system that renders the chickens unconscious before the birds are handled by plant workers.  The company says it is working with its U.S. and Canadian pork suppliers to reduce the use of crates. 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

PEET: Peet’s coffee gained 5.5% on accelerating volume.  Declining coffee prices continue to help this company.

 

 

CASUAL DINING

 

BJRI: BJ’s Restaurants was raised to Outperform from Neutral at Wedbush.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

DRI: Darden declined on accelerating volume as concerns about the “choppy” macro environment and seafood inflation at Red Lobster.

 

THE HBM: BEEF, WEN, BJRI - stocks 2

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


Entitled Credit

This note was originally published at 8am on March 12, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If your success was due mostly to chance, how much credit are you entitled to take for it?”

-Daniel Kahneman

 

That’s an outstanding question from one of the outstanding contributors to our profession in the last decade. Now that The Baupost Group’s ($22B) founder Seth Klarman focused his recent quarterly letter on Dan Kahneman’s work, I feel special.

 

Do you feel special? Do you need someone “smart” to validate your ideas for them to be good ideas? Kahneman’s focus in Chapter 20 of “Thinking, Fast and Slow”, The Illusion of Validity, at a bare minimum will get you thinking about what you really know.

 

“The illusion of skill is not only an aberration, it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed.” (Kahneman, page 217)

 

Back to the Global Macro Grind

 

Threaten how people get paid in any diameter of this business, and I can assure you they, deep down, want you to fail. That’s the kind of adversity I live for. Welcome to Wall St 2.0.

 

On Larry Kudlow’s WABC Radio Show this weekend, Larry asked me a very simple question related to this topic of what Old Wall Street really wants: “Keith, do you think that Wall Street types want a weak dollar?”

 

Yep. Big time.

 

How else can you explain the US Dollar Index’s most recent history and the Street being willfully blind to its realities?

  1. Down -19% from Bernanke’s start date (2006) to the thralls of Qe2 (Q211)
  2. Down -12% from Obama/Geithner start date (2009) to the lows of 2011
  3. Down -4% from Bernanke’s January 25thpush to debauch to 2014 to the lows 1 month later (last wk of Feb)

Actually, the “smart” people would call this correlation instead of causality. Right. Right. Like there is no causality between the largest money printing and debt monetization in US history and the US Dollar that underpinned it.

 

Let’s get serious here folks. The reason why we’re one of the few Wall St 2.0 firms focused on the US Currency’s Credibility is that we don’t get paid exclusively by the short-term inflations of asset prices (stocks, commodities, etc.) born out of debasing it.

 

This American Purchasing Power point holds plenty relevant for the upcoming US Presidential Election too. There is currently a very high correlation between President Obama’s approval rating and the inflation of the US stock market. That’s why we have back-tested and built the Hedgeye Election Indicator using real-time market indicators. We’ll be updating that every Tuesday morning.

 

Back to the market.

 

Last week was a good week for my Strong Dollar = Strong America theme:

  1. US Dollar Index = recovered a +0.81% appreciation to $80.04
  2. CRB Commodity Inflation (18 commodity index) = deflated by -1.2% to 317
  3. Short-term US Treasury Yields (2-yr yields) = rose +18.5% to 0.32%

Since this all happened on the heels of continued Romney momentum in the Republican primary (sorry CNN fans, I know this wasn’t their headline), we’re left to wonder whether this weekend’s Rasmussen poll of Romney 48% vs Obama 43% will line up with our Hedgeye Election Indicator’s directional signal tomorrow morning.

 

Like everything we build here, our election indicator is built with math, not partisan politics. If you’re a Democrat and it’s hard to read the Rasmussen data point, tough cookies. It should be equally hard for Republicans to read our last Election Indicator of an Obama +58.4% probability to win.

 

I’m not a Republican or a Democrat. I am Canadian – and couldn’t be more proud to not be pigeon holed into being associated with an American political party. So, hopefully, for Election 2012, we can become one of your objective and bi-partisan sources in handicapping the #1 issue in this country – the economy.

 

On that score, there was a lot of spin on last week’s unemployment reporting – so let’s un-spin it:

  1. The US unemployment rate did not improve month-over-month, staying at 8.3% (only down 0.7% year-over-year)
  2. Taking out the government’s random Birth/Death “Adjustment”, the monthly payroll print was +28,000 y/y (yawn)
  3. At 63.9%, the US Labor Force Participation rate was second lowest ever (to January 2012’s print)

The lowest Labor Force Participation rate ever? Yes, ever is a long time. And so is the Entitled Credit that both the Bush and Obama Administrations have taken for stock and commodity market inflations that have netted out to ZERO US jobs added in the last decade. It’s the Weak Dollar Policy, stupid.

 

My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar Index, and the SP500 are now $1691-1710, $104.98-108.65, $79.36-80.24, and 1364-1383, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Entitled Credit - Chart of the Day

 

Entitled Credit - Virtual Portfolio


MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY

Key Takeaways:

* Spain and its banks are getting worse. Spanish bank default swaps were materially wider week-over-week, rising an average 74 bps, or 18%. All six of Spain's major banks, on which swaps trade, are trading well over 300 bps (the "Lehman line"). Spanish Sovereign swaps widened by 27 bps to 427 bps. While most investors are focused on the rapid deterioration taking place in Portugal, we think Spain is the one to watch more closely. Will 2012 be a redux of 2011 on the Europe front, this time with Spain playing the lead role? Looking at sovereign and bank swaps of a country in conjunction has generally been a solid cointegrated risk measure.    

 

* Euribor-OIS continues to improve. It fell 3.5 bps to 44.7 on Friday. The Euribor-OIS spread is moving closer to re-normalized levels of 30-35. Meanwhile, the TED spread rose 1 point WoW, ending at 39.9.

 

* Both American and European Bank Default Swaps were wider over last week.

 

* The MCDX measure of municipal default risk fell sharply week over week, ending last week at a YTD low.

 

* Bullish Short-Term Quantitative Setup -  Our Macro team’s quantitative setup in the XLF shows that there is 1.9% short-term upside in the XLF vs. 0.4% short-term downside. 

 

Financial Risk Monitor Summary  

• Short-term(WoW): Neutral / 3 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged

• Intermediate-term(WoW): Positive / 6 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged  

• Long-term(WoW): Negative / 3 of 12 improved / 4 out of 12 worsened / 5 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Summary 2

 

1. US Financials CDS Monitor – Swaps widened for 22 of 27 major domestic financial company reference entities last week.   

Widened the most WoW: GS, AGO, MBI

Tightened the most WoW: MTG, RDN, HIG

Widened the most MoM: MBI, MMC, AON

Tightened the most MoM: BAC, WFC, AIG

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - CDS  US

 

2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.6% and the median widening was 6.0%.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - CDS  EURO

 

3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. American sovereign swaps tightened by 7.2% (-2 bps to 30 ) and Spanish sovereign swaps widened by 6.6% (27 bps to 427).

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Sovereign CDS 1

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Sovereign CDS 2

 

4. High Yield (YTM) Monitor – High Yield rates rose 12.4 bps last week, ending the week at 7.13 versus 7.01 the prior week.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - HY

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.93 points last week, ending at 1648.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - LLI

 

6. TED Spread Monitor – The TED spread rose 1.0 point last week, ending the week at 40 versus last week’s print of 39.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - TED2

 

7. Journal of Commerce Commodity Price Index – The JOC index was flat week over week, ending Thursday at -7.7. Data was not available for Friday.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - JOC Index

 

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 3 bps to 45 bps.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Euribor OIS

 

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.  

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - ECB

 

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 110 bps versus 115 bps the prior week.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - MCDX

 

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 rose 34 points, ending the week at 908 versus 874 the prior week.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Baltic

 

12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread tightened to 188 bps, 5 bps tighter than a week ago.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - 2 10  2

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.9% upside to TRADE resistance and 0.4% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - XLF

 

Margin Debt - February: +0.85 standard deviations 

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, it 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. 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. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.  The chart shows data through February.

 

MONDAY MORNING RISK MONITOR: SPANISH BANKS AND SOV CDS WIDEN SHARPLY - Margin Debt

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.

 

 


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