C.M.O. 8.24.2009
Credit Market Overview
August 24, 2009
In this age of constant contact we email, IM and now Twitter with such rapidity that time itself seems be passing even faster than it actually is.
It would appear the stock market is in tune with the new trend as corrections barely get above the 3% level and are over in two days. One of the interesting things about the hiccup that lasted for the Friday and Monday trading sessions a week ago was that it was triggered by a lower than expected University of Michigan Confidence Survey number.
Professor Sydney Ludvigson of NYU has studied such numbers and found that only about 15% of a person’s tendency to spend can be explained by these numbers and it is not determinable, according to the good professor, whether the confidence number is just an expression of the public’s re-interpretation of other economic statistics or a true change in their outlook. The one thing Sydney could say was that confidence tends to build confidence. To which I would add; with a deck of cards you can build a house of cards.
A similar phenomenon might be at work in the latest Leading Economic Indicator number as the Index of said indicators rose 0.6% in July which was used by the market as a reason to be bullish. A closer examination of the components of the ILEI shows that about 80% of the 0.6% came from the financial subcomponent. Or, more plainly, stocks were going up because the Leading Indicator was rising, which was rising because stocks were going up. Talk about having carbohydrates with your carbohydrates that’s pretty much like eating a pasta sandwich.
The low volume has been blamed for the exaggerated moves of late but it also seems like the market spins the direction wheel each day and decides whether to go up, down or sideways regardless of the economic release as the increase in Mortgage Delinquencies and Initial Jobless Claims last Thursday did nothing to dissuade the market from advancing.
The CDS market is often thought to lead the equity market but in actuality there is about a 40 day window (-20/+20) where either the CDS or equity can begin to move before that move is confirmed by the other market. That’s where the science becomes art in managing the CEC Portfolio.
In an effort to filter the daily noise emanating from the market’s reaction to the number du jour the main driver in the buy/sell decision process for the CEC Strategy is CDS movement and after last week all I can say is; no indicator is perfect.
CDS spreads, as measured by the CDX Indices began to widen in earnest on August 10th moving from 106bps on that day to 120 by August 14th. As this is usually a negative for equity prices we were paying close attention to our long positions, ready to cut them loose should prices begin to fall (remember that 40 day window I talked about).
When equity prices dropped on August 14th it made sense, based on history, to begin jettisoning long positions. Monday’s further rise in credit spreads to 123bps and falling stock prices removed a very good portion of what ever longs remained and a number of short positions were entered.
A saw tooth pattern in CDS Index spreads between the 17th and the 20th gave no hint of what was to come although on an individual basis there were some names that saw narrowing spreads and rising equity prices so these longs were initiated and/or shorts covered as it became appropriate throughout the week.
Then came Friday and an Existing Home Sales number that was way out in the tails relative to expectations and CDS spreads collapsed and the market took off like a rocket, causing the second major position reversal in a week. Just in case you were wondering this is never a good thing for your P/L, NEVER!
Looking behind the Existing Home Sales numbers it appears it could be another “confidence builds confidence” situation as a good portion of the increase was due to investors paying cash for foreclosed residences and then using them as rental properties. I’m not saying paying cash for something isn’t a sale but it is also pretty far from an economic environment where people who are secure in their jobs are taking out mortgages and buying homes they intend to live and raise their families in.
As we have seen all too often throughout these past 2+ years, reality infrequently has much to do with how the market behaves.
For myself, I’m just hoping the head fakes in CDS land stay few and far between.
Enjoy the week.
Jim Delaney
