C.M.O. 6.10.2009
Credit Market Overview
June 10, 2009
“Grasping at straws” is a phrase we here from time to time and its etymology is actually “A drowning man will catch at straws” first tracked back to ‘Dialogue of Comfort Against Tribulation’ (1534) by Thomas More (1478-1535). First cited in the United States in ‘Colonial Currency’ (1720). (Thank you Yahoo! Answers)
The point here being that investors are looking at whatever they think will give them insight into what’s to come as many of those investors are drowning in red-ink from the market’s decline.
With this said, Jason Goepfert of www.SentimenTrader.com looked at the markets at the end of May and observed that the market had just completed four straight weeks in which the weekly highs were within 0.75% of one another; and weekly lows were within 0.75% of one another. Jason’s research showed that since 1928, such a four-week stretch of stasis has lasted another week only 17% of the time, and only once has continued for a sixth week.
The breakout to a higher level on June 1st supported Mr. Goepfert’s research but the market has stayed in the shadow of the market’s range on the first day of this month pretty much since then. Early on in my career a crusty old practitioner once grumbled that the market moves sideways 75% of the time. I always find it interesting how experience and a logical mind can match quantitative machinations with exacting precision.
Staying on the quantitative theme for just a moment longer Michael Santoli recently observed in Barron’s that on a three month basis, the correlation among all stocks has been running above 0.8%, suggesting that 80% of any one stock’s movement is determined by the direction of the overall market; an alpha-hunter’s nightmare to be sure!
With 400+ names in the CEC universe and positions in 173 of them, the long short skew of 137/36 as of last nights close would appear to be support or be supported by the two statistical abstracts previously mentioned.
Worth nothing here is that positions in the CEC Portfolio do not look at any of the quantitative crunches described earlier but simply the relationship between the CDS spread and equity price movement of a single entity.
While examining the workings of a single market can reveal some interesting way signs and guide posts seeing corroborating evidence across markets or asset classes adds a new layer to the intricacies of the forces behind the market’s movement.
There have been a few instances over the life of the current credit cycle where the correlation of movements within the CDS market has also been very high and although not old and crusty I would say that the number was close if not higher than the 80% Mr. Santoli cited.
The run up to the market top in October of 2007 saw many investment managers reaching for what was bandied about at the time as “incremental yield”. This was a rather high-brow term for the process of pushing further out the maturity spectrum and wading deeper into the pool lesser quality names to grab a basis point or two of performance. The need to outperform became intense as the market itself was racking up impressive gains.
Correlation was high as well throughout most of 2008 as visions of the immanent destruction of the world’s financial system volleyed with exogenous forces working to prevent financial ruin.
Super-high levels of correlation among names in the CDS market have subsided somewhat although that is a relative designation similar to how 40mph feels slow when you on the off-ramp after having just been traveling at 70mph on the highway. (”Last time I looked, 55, officer.)
Looking at CDS spreads alone could lead one to anticipate higher stock prices and the ratio of longs to shorts in the CEC Portfolio, currently 3.8:1, supports this. In this environment, however, the trick becomes not that things in general are moving higher but determining how much of that movement is name specific and how much is market induced.
Enjoy the week.
Jim Delaney
