Takeaway: Risk is now more positive than negative in the short-term, but the intermediate and longer-term durations still skew negatively.
Risk has been in modest retreat for the last two weeks alongside an emergent stabilization in oil in the low $30s and the less bad than feared +1.0% GDP print on Friday. We wouldn't take too much comfort from that as risk in Asia continues to creep higher. The Chinese Interbank Rate, a gauge of systematic stress in the Chinese banking system, notched up by 11 bps week over week to 2.05%, its highest level since April 2015. Additionally, the median CDS spread in Asia widened by 5 bps last week, bringing the M/M change to 11 bps.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 4 of 13 improved / 3 out of 13 worsened / 6 of 13 unchanged
• Intermediate-term(WoW): Negative / 4 of 13 improved / 7 out of 13 worsened / 2 of 13 unchanged
• Long-term(WoW): Negative / 1 of 13 improved / 6 out of 13 worsened / 6 of 13 unchanged
1. U.S. Financial CDS – Swaps tightened almost across the board for US Financials as 4Q15 GDP came in better than expected. The median contract tightened by -9 bps to 100 last week.
Tightened the most WoW: JPM, C, HIG
Widened the most WoW: MMC, CB, XL
Widened the least/ tightened the most WoW: JPM, TRV, LNC
Widened the most MoM: AIG, MMC, PRU
2. European Financial CDS – Swaps were mixed across European banks last week with essentially no W/W change in the median.
3. Asian Financial CDS – Swaps on Asian banks were flat to wider last week, led by the increase at State Bank of India which widened by +13 bps to 195.
4. Sovereign CDS – Sovereign swaps were mixed last week. On the positive side, Portuguese sovereign swaps tightened the most, by -20 bps to 326. On the negative, Irish swaps widened by +7 bps to 66.
5. Emerging Market Sovereign CDS – Emerging market swaps mostly tightened last week. Brazilian CDS tightened the most, by 19 bps to 455, as the country's central bank reported that Brazil's budget deficit narrowed in January, although the improvement came from one-time revenue sources.
6. High Yield (YTM) Monitor – High Yield rates fell 28 bps last week, ending the week at 8.56% versus 8.84% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 7.0 points last week, ending at 1789.
8. TED Spread Monitor – The TED spread was unchanged last week at 32 bps.
9. CRB Commodity Price Index – The CRB index fell -0.5%, ending the week at 162 versus 163 the prior week. As compared with the prior month, commodity prices have decreased -3.0%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
10. 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 widened by 1 bps to 15 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index rose 11 basis points last week, ending the week at 2.05% versus last week’s print of 1.94%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China rose 2.6% last week, or 54 yuan/ton, to 2125 yuan/ton. 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 to 97 bps, -7 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread tightened by 1 bps to 39 bps.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
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The Yen is ramping (again) vs. USD this morning and that is not a good thing when it comes to the #BigBangTheory as it keeps Japanese stocks (Nikkei -1% overnight and -23.1% since last year’s high) in crash mode with no “G20 help” this weekend.
European stocks had their slow-volume bounce last week (EuroStoxx600 +1.6% to -9.4% year-to-date), but resume their crash this morning with the DAX -1.6% (down 13% year-to-date and -24% from 2015 top) post a #Deflation print of -0.2% year-over-year for Eurozone CPI. The Swiss 10YR falls to -0.45% as #NIRP continues to perpetuate #Deflation.
The UST 10YR didn’t really budge during last week’s U.S. stock market levitation – more importantly, with the 10YR = 1.74% this morning, the Yield Spread has compressed to another new low of 96 basis points wide (10s/2s) and that keeps the Financials (XLF) as our favorite S&P Sector Short vs. Utes (XLU) long.
*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE.
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Our preferred growth slowing vehicle remains Utilities (XLU) in equites. Hitting on Friday’s revised GDP report (Q/Q SAAR Q4 GDP revised to +1.0% from +0.7%), a deep-dive into the number doesn’t support an incrementally stronger economy:
General Mills (GIS) hit an all-time high last week when it reached $60.18 on Thursday. Although this would not be a great entry point, it is also not a reason to get out if you have a long-term view. Nothing has changed in our fundamental story and we have no reason to lose faith in our thinking to date.
Over the course of the past few years, GIS has made strategic acquisitions within the natural & organic / wellness space (we call it the string of pearls approach). Although they are not largely meaningful to top or bottom-line right now, they are changing the way the company thinks about its broader portfolio.
We continue to believe GIS is one of the best positioned consumer packaged foods companies due to its strong brands and best-in-class people and organization.
Our preferred growth slowing vehicle remains (Long-Term Treasuries) TLT in fixed income. A flattening in the yield spread (10YR Treasury Yield – 2YR Treasury Yield) continued last week into double digit basis point territory (currently at 96 basis points). Year-to-date the yield spread has declined 44 basis points while the 10YR Treasury Yield has dropped 47 basis points. As a reminder the yield curve flattens as the economy slows with policy and/or liquidity management driving the short-end higher and defensive positioning and/or discounting of lower future growth/inflation driving the long end lower.
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Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.
"... On that score, after another #Deflation report out of Europe this morning (Eurozone CPI -0.2% y/y FEB vs. +0.3% JAN) and the Chinese panicking with another “RRR cut” (post their stock market dropping another -2.9% overnight), the German DAX just gave back all of last week’s “bounce” (-1.6%) and remains in crash mode at -24.4% from last year’s #bubble peak."
“Unlike lying, an imagined reality is something that everyone believes.”
-Yuval Noah Harari
Or at least people don’t “feel” like they are lying when they are obfuscating the truth about either the economy or the profit cycle. As long as enough perma bull people are paid to perpetuate the spin, everything is ok – until it isn’t.
As Harari explains in an excellent chapter called The Tree of Knowledge, “over the years people have woven an incredibly complex network of stories… and the kinds of things people create through this network of stories are known in academic circles as fictions, social constructs, or imagined realities…” (Sapiens, pg 31)
For example, if the Old Wall wants you to imagine that Friday’s 1% GDP report was a “beat” (when the expectation for the past 2 years has been +3-4% growth), that’s fine. Your 2016 portfolio returns, however, have sided within being long asset allocations that do well when GDP growth slows from 3 to 2 to 1. So start your March off right - short the Financials (XLF) – buy more Utilities (XLU).
Back to the Global Macro Grind…
What our profession refers to as “month-end” can sometimes be as magical as Disneyland. On no volume at all (the sellers take a break), prices can levitate – and, as long as you close your eyes, you can believe that you are actually flying (or tell your kids they are).
Then the ride ends, and you’re back in another line thinking “why am I doing this?” Why are you suspending the very basic belief that life is just a long line of hopeful expectations? Cycles take time to play out.
With US “stocks up” for the 2nd straight week last week, “ex-stocks” here’s how the rest of the ride went in Global Macro:
In other words, last week was what we call a counter-TREND (i.e. counter to what’s been really working) move where the asset allocations that are really working (positive absolute returns) barely corrected.
Meanwhile, back on Space Mountain (Global Equities), here’s how the week looked:
Yeah, the “bounce” was fun. But when everyone got off the ride, they looked at their YTD equity return and vomited.
As you probably noted, “Dollar Up” weeks still hammer the poor bastards who are long “EM, China, etc.” … and they give hope to those begging for the currencies in the equity markets they are long (Italy and Japan) to be devalued…
But what happens when the music stops? What happens when everyone comes to realize that the truth about US growth is somewhere in between 0 and 1.5% and the rest of the world’s #GrowthSlowing and #Deflation risks have not gone away?
From a US Equity Style Factor perspective, Mr. Macro Market just reminded us that it’s being long the following exposures that gives you the biggest bang for your buck (provided that you weren’t long any of them during the decline!) on bounces:
*Mean performance of Top Quintile vs. Bottom Quintile (SP500 companies)
Yep. Getting on some of these rides is definitely racy, but if you’re awesome at threading the needle and whipping your entire portfolio into all of the things that have crashed… you’re all set, until they start crashing again.
On that score, after another #Deflation report out of Europe this morning (Eurozone CPI -0.2% y/y FEB vs. +0.3% JAN) and the Chinese panicking with another “RRR cut” (post their stock market dropping another -2.9% overnight), the German DAX just gave back all of last week’s “bounce” (-1.6%) and remains in crash mode at -24.4% from last year’s #bubble peak.
Enjoy whatever is left of the month-end markup in US stocks. Both March and the February US Employment data are coming. And our version of this interconnected story will be non-fiction.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.68-1.81%
Oil (WTI) 27.72-34.41
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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