Key Takeaways
* Still Positive. Overall, there was more positive than negative again last week in our risk monitor. We saw short term improvements from 4 of the 13 metrics we track (EU Financials CDS, Asia Financials CDS, EU Sovereign CDS, and High Yield). Meanwhile, we saw deterioration in 2 of the 13 metrics (Chinese Steel and U.S. Financials). On an intermediate term basis, the positives (5) narrowly outweigh the negatives (3), while on a longer-term basis, there are decidedly more positives (6) than negatives (2).
* European Swaps: European bank and sovereign swaps tightened last week as Europe reached some consensus on a debt deal for Greece. Our European Analyst, Matt Hedrick, wrote the Early Look last Thursday, providing insight into the pros and cons of the deal.
* U.S. Bank CDS: Swaps tightened for 16 out of 27 domestic reference entities. The majority of the widening week-over-week took place in insurance companies. The money center banks, large brokers, and consumer finance companies mostly tightened.
* High Yield: The average rate on high yielding corporate debt fell 22 bps from 6.78% to 6.56%.
* Chinese Steel: Chinese steel declined another 107 yuan/ton (or 2.9%). Over the last several weeks, steel prices in Chine have resumed their decline. This comes after a brief rally which peaked on October 10th, 2012. Chinese steel prices are now 7% lower than they were on October 10th.
* Quantitative Setup: Our Macro team’s quantitative setup in the XLF shows 0.8% upside to TRADE resistance and 0.3% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 4 of 12 improved / 2 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Positive / 5 of 12 improved / 3 out of 12 worsened / 5 of 12 unchanged
• Long-term(WoW): Positive / 6 of 12 improved / 2 out of 12 worsened / 5 of 12 unchanged
1. American Financial CDS – There was very little movement in money center bank swaps or major investment bank swaps last week. The largest moves came from GS (-2 bps) and MS (+2 bps). This was the case for the rest of the U.S. financial sector as well, with the exception of the mortgage insurers and MBIA, where there were large declines in swaps.
Tightened the most WoW: MBI, MTG, SLM
Widened the most WoW: ACE, HIG, AON
Tightened the most MoM: JPM, GNW, C
Widened the most MoM: RDN, AIG, ACE
2. European Financial CDS – European banks were generally tighter WoW with the exception of Greece, where bank swaps rose significantly. Overall, 32 of 37 financial reference entities in Europe were tighter last week on the heels of Monday's Greek debt announcement.
3. Asian Financial CDS – Swaps were notably tighter in Asia last week with all reference entities we track in China, Japan and India showing improvement.
4. Sovereign CDS – European sovereign swaps posted another week of significant tightening, led by Spain (-34 bps) and Portugal (-26 bps). Italy was close behind at -22 bps. The only major country that widened last week was the U.S., higher by 1 bp.
5. High Yield (YTM) Monitor – High Yield rates fell 22 bps last week, ending the week at 6.56% versus 6.78% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 7 points last week, ending at 1731.
7. TED Spread Monitor – The TED spread rose 0.9 bps last week, ending the week at 23 bps.
8. Journal of Commerce Commodity Price Index – The JOC index rose 2.2 points, ending the week at 0.39 versus -1.8 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread widened by less than a basis point to 12.6 bps. 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.
10. 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.
11. Markit MCDX Index Monitor – Last week spreads widened by ~3 bps, ending the week at 133 bps versus 130 bps the prior week. 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 16-V1.
12. Chinese Steel – Steel prices in China fell 2.9% last week, or 107 yuan/ton, to 3566 yuan/ton. Since their recent highs on Oct 10, Chinese construction steel prices have fallen ~7%. The broader downward trend, which started August of last year, remains intact and is a sign of ongoing weakness in the Chinese construction market. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened 5 bps to 137 bps. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.8% upside to TRADE resistance and 0.3% downside to TRADE support.
Margin Debt – October: +1.19 Standard Deviations
NYSE Margin debt rose to $318 billion in October from $315 billion in September. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at margin debt levels in standard deviation terms over the period 1. Our analysis finds that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of significant risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value over the following 24-36 months. Overall 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 October.
Joshua Steiner, CFA
Robert Belsky