July 1, 2009

If sixty is the new forty and as the hedge funds were saying last year, flat is the new up, then watching the market yesterday can only lead one to believe that breaking windows is the new window dressing.  If PM’s want to own the hottest stocks when the market is on its way up then maybe they used yesterday to off load the dogs they had on the books.

Last Friday, along with news that consumers were saving more than they had at anytime since 1993 as the personal saving rate was reported by the Commerce Department to have risen to 6.9% came the release of the University of Michigan/Reuters Consumer Sentiment Index rising to 70.8 breaking through the previous high of 70.3 set in September of last year.

Yesterday’s release of Consumer Confidence by the Conference Board contradicted last Friday’s number and not only declined from the previous post of 54.9 but fell short of expectations by 6 points or roughly 10.8%.

Contradiction seemed pervasive in June as headlines like “Corporate Bonds Are Signaling Growth” were countered with others reading; “Summertime, and the Credit Ain’t Easy”.

A look at the CDS indices shows a similar pattern.  On the investment grade side the index closed at 138.0 on the last day of May and at 131.4 on the last day of June.  Had you Rip Van Winkled it would appear to have been a quiet month with a slight improvement in credit spreads; something not unexpected during what are usually those “Lazy, Hazy, Crazy Days of Summer”.

As New Yorkers are all too well aware June was not hazy and lazy but the weather was crazy as it was supposedly the wettest June since records have been kept.  The credit markets were a bit more stormy than the opening and closing quotes would lead you to believe as within the sixth month IG spreads were as low as 120.6 on 6/5/2009 and as high as 145.8 on 6/22/2009.  Slicing and dicing those numbers shows that the range for the month (25.2pts) was just about four times the movement for the entire month (6.6pts).

High Yield spreads started June at 1036.7pts; broke through the 900pt level on 6/12/2009 to close at 896.4pts and then made their way, right quick like, to 1065.1pts in just six trading days.  Winding up the month at 948pts the HY index improved by 88.7pts or 8.55% over the month but ranged 168.7pts in the meantime.  The movement to range ratio was just under 2 on the high yield side but reasonably mind bending when you experience an 8 and a 10 handle on the index within the same month.

The debate as to whether the green shoots are growing or wilting seems destined to be fought in the media.  With low summer volumes and lack of conclusive evidence as to which side is winning, the forecast is uncertain at best but with the rain in NY continuing into July and the kind of volatility seen in June keeping your powder dry and yourself seems to be the most prudent way to approach the new month.

Enjoy the short week,

Jim Delaney

]]> http://www.marketstrategiesmgmt.com/2009/07/cmo-712009/feed/ 0 http://www.marketstrategiesmgmt.com/2009/06/cmo-6302009/ http://www.marketstrategiesmgmt.com/2009/06/cmo-6302009/#comments Tue, 30 Jun 2009 10:47:47 +0000 Jim Delaney http://www.marketstrategiesmgmt.com/?p=428 Credit Market Overview

June 30, 2009

One of the truly fascinating things about the market and by “market” I mean the sum of the equity, fixed income and commodity markets, is that at any given point in time a set of factors can be considered bearish and at another point in time the exact same set of factors can be considered bullish.

The case in point is oil.  Last year at this time we were seeing the WTI Crude futures contract trade at over $140/bbl, the USD, represented by the DXY index was trading in the low 70’s and we were peering into the abyss.

Oil is trading at about half of last year’s peak but up close to 70% from it’s lows earlier this year, the DXY is trading at 80+/- down 11% from it’s early March high and yet the equity market is moving higher, albeit in fits and starts with almost every letter in the alphabet being used to describe the shape of it’s recovery.

One of the reasons given for the latest push above the $70/bbl number for crude is a supply disruption in Nigeria as Royal Dutch Shell said that militants had forced the shutdown of a pipeline facility.

At the same time and as a possible counter to the Nigerian issue, Iraq, this week, is planning to auction off contracts to foreign firms to help revive production at six developed fields that are under-producing as a result of the war.  With 115BN barrels of proven reserves, Iraq’s supply is thought to be among the worlds largest but production is just 2.4MM/bbls/day when it has been as high as 4MM/bbls/day in the past.  At current prices that’s $112MM/day the country is missing out on.

Now before you go shorting the NYMEX contract out the wahzoo understand that there are some issues to be considered.  The contracts run for 20 years and are “serviced-based” which means the winners will not be able to count Iraq’s reserves as their own.  Additionally, there has been a “request” for $2.6BN in “soft loans” (a little money “under the tent” as it were) from the government to those who should be lucky enough to win the opportunity to invest in a project where suicide bombings occur with the same regularity as the 3:10 to Yuma and a shaky legal structure persists despite three years of debate regarding petroleum resources.

With that said there were about 120 companies that expressed interest in the project and 35 of them qualified to bid including Exxon Mobil (XOM), Royal Dutch Shell (RDS), Lukoil (LUKOY) and Sinopec (SNP).  All but XOM trade in this country as ADR’s as well as their home exchanges but only XOM and RDS have CDS contracts.

XOM’s CDS levels have come down dramatically from their peak last December 16^th of 115bps to a recent low of 36bps on June 3^rd and closed at 40bps last night.  The stock price has traveled a less smooth road moving off its high, also on 12/16 (unusual because of the positive correlation) to a low of $62.22 on March 5^th of this year when the CDS closed at 70bps.  Since March the stock moved higher while the CDS moved lower but the most recent high in the stock ($74.05; 6/11/2009) has not been bested during oil’s latest move higher.  XOM closed at $70.58 last night and bounced off of what appears to be support at around the $68 level on June 24^th.

RDS’s stock price peaked at $59.65 last November 4^th just a day after the CDS bottomed at 72bps.  There has been a higher degree of positive correlation between the equity and CDS market for RDS as both declined from late last year until late April of this year when they both went their separate ways again.  Like XOM the CDS level has exhibited less volatility and a steadier move lower while the stock also peaked in early June and has yet to regain those highs.

The auctions in Iraq were scheduled for the 29^th and 30^th of June.  We will have to wait to see if a winning bid in the auction results in more bids for the stocks of those in the oil business.

Enjoy the short week,

Jim Delaney

June 26, 2009

The actions of the Federal Reserve under Alan Greenspan are considered to be a leading cause of that which has come crashing down all around us lo’ these past two years.  Alan continues to do what he thinks he does best and that is to analyze data to see as far into the future as he can; even if that is only the past.

A.G. was heard to say recently that “the crisis cannot end fully until home prices in the U.S. are at least stabilizing”.  That seems to make good macro-economic sense regardless of who is saying it.  The question then becomes: are home prices stabilizing?

The quick answer is no.  The National Association of Realtors reported this week that the median sale price of and existing single family home at $172,900, was 16.1% lower in May of 2009 than in that same month in 2008.

S&P/Case-Schiller maintains a few other slightly more complicated measures of home prices, but you would expect nothing less from a Yale professor and half of the team that brought you securitized debt that magically turns from AAA to BBB when the going gets rough.  In any case, the indexes looked after by S&P/C-S for the 10 and 20 largest metropolitan areas in the country show a close to a 19% decline from 1Q08 to 1Q09.

In true government fashion, the Federal Housing Finance Agency, which limits its monitoring to only those homes sold that were financed with mortgages backed by FNM and FRE showed a 6.8% decline year over year.  In all fairness, until someone in D.C. decided to “roll the dice” by lowering FNM’s and FRE’s lending standards a FHA mortgage was not that easy to get so it would make sense that well-healed buyers bought in tony areas and have been somewhat insulated from the carnage going on in FL, AZ and of course, CA.

Mr. Greenspan also sees most of the problem being created after 2005 and says; “the bulk of conforming mortgages made since 2005 are close to being underwater”.  For those hoping for a slowing in the rate of decline we can all only hope your wishes come true as Alan estimates; “We can take another 5% decline in house prices without much macroeconomic impact”.  But, he says; “if prices fall by more than 12%, more than four million additional home-owners will be underwater”.

Seeing as by some measures we’ve just dropped 19% YoY somebody better find the brake pedal quick and stomp on it hard.

A few days ago I wrote about Lennar (LEN) and how they were buying back property, on the cheap, that they had previously sold at a dear price.  LEN is not alone in its efforts to emulate Rahm Emanuel and “not waste a good crisis” as a number of home-builders are actually buying more land to build more houses.  The trick here is that that properties are primarily owned by the banks and are selling at prices that amount to the cost of turning raw land into buildable lots e.g. the cost of knocking down the trees and putting sewers and roads in.  In these deals, the land itself is essentially free.

All of this bodes well for the builders once we come out of this recession but the timing of that exit appears in question as the 5% buffer Mr. Greenspan talks about seems awfully close at this point.  More so given that by certain measures the rate of decline is still in the high-teens.

The CEC Strategy has been short a number of names in the home construction and remodeling space since mid-to-late May, depending on the name.  This was the result of widening CDS spreads and lower equity prices.  This week’s economic announcements have caused a bit of a reversal in those relationships with the XHB hitting an intra-day low of $11.05 on Tuesday the 23^rd but closing last night on its highs at $11.91, a 7.78% increase.  MTH in particular has had a great run off of its closing low of $$16.44 on June 16^th to its close last night at $19.18, a 16.7% pop and enough, when combined with a narrowing CDS spread, to close out the short position.

Needless to say shorting low dollar value stocks can be exhilarating as it doesn’t take a big nominal price movement to bust through your risk parameters on a percentage basis.  It remains to be seen if the other home-builder names will carry through or if, given the quarter and half-year end window dressing, this is just a flash in the pan.

One thing that can be surmised however, is that if the 2/3rds of Americans who own their homes and for whom it is their largest investment continue to suffer price declines and are therefore locked into living where they are living, it won’t matter how cheaply the builders can acquire land because there won’t be anybody moving anywhere.

Enjoy the weekend,

Jim Delaney

June 24, 2009

Commercial Mortgage Backed Security (CMBS) delinquency rates are up by a factor of 3 in the last six months hitting 2.7% in May, which if you’re keeping score, is the highest level in a decade.  Additionally there are $155BN of CMBS loans coming due between now and 2012.  Of these Deutsche Bank believes about 66.6% won’t qualify for re-financing.  The punch was sweet but is the party ending?

Standard & Poors, continues to set the new standard in credit discipline and has recently warned that billions of dollars of top rated CMBS backed bonds could be headed to the downgrade doghouse.

S&P’s actions run counter to the Treasury’s plan to offer low-cost, nonrecourse financing to CMBS buyers as, according to the TALF rules for investors in this asset class, only the highest rated CMBS are eligible.

Timothy Geithner said recently that “this program is critical to restoring the flow of credit to owners of commercial real estate and preventing a damaging chain of events in this market”.  Needless to say after the last year and a half we all know what a “damaging chain of events” looks like.

The CMBS market is about $700BN in size but with $230BN of that issued in 2007, the year with the highest issuance on record and probably the lowest lending standards, it would appear that about 1/3^rd of the issuance is on less than a solid foundation.  For those keeping box scores issuance in 2008 was just $10BN and $0.00 through the end of May of this year.

Under their new guise as concerned corporate citizen and credit watchdog S&P recently announced changes to the way it rates CMBS’s which would result in a good portion of the “AAA” rated paper synthesized between 2005 and 2007 losing its vaunted rating.  In case you haven’t guessed, only AAA paper is allowed in the TALF program.  The loans made during said period were extended as a result of “increasingly more aggressive underwriting” standards than in prior years according to S&P.

The CEC Portfolio currently has positions in just four of the 21 names tracked by the Strategy in this sector but all of those are on the short side.  The names include: AMB, EQR, HCP and VTR.

The sector, as you might imagine, trades on a pretty highly correlated basis but there are enough differences in the CDS/equity movement of each name that the sector cannot be traded as a block.  All of the existing shorts in the REIT sector were profitable as of last night’s close.

CDS spreads bottomed back on June 11^th and have risen back to levels seen in mid-May since they’ve turned.

There are many questions now regarding whether the “green shoots” we keep hearing about will get enough of what they need to continue to grow.  The commercial real estate market is being used by many as a form of weather radar in hopes of determining whether there are clear skies ahead or storms on the horizon.

Enjoy the week,

Jim Delaney

June 23, 2009

While running some errands over the weekend I passed one of those shops that sell cards and candles and those magnets that everyone’s refrigerator boasts at least one of.  There were also a few of those posters with various sayings on them one of which said something like; “you can’t keep doing the same thing and expect different results”.  Seemed obvious, made sense, so I filed it in the back of my mind with all of the other useless information.

Then, while reading the paper yesterday, it became clear.  It seems that the Chairman of the House Financial Services Committee, Barney Frank (D., MA) and Anthony Weiner (D., NY) are pushing to have FNM and FRE to relax recently tightened lending standards on mortgages for new condominiums, with Mr. Weiner saying the new standards “may be too onerous”.

In March FNM said it would no longer guarantee mortgages on condominiums where fewer than 70% of the units have been sold, which is higher than the 51% number the bar was previously set at.  FNM and FRE have also raised the fees on mortgages for lenders that cannot make at least a 25% down payment.

Charles Foschini, vice-chairman of CB Richard Ellis in South Florida had his own opinion on the new lending standards saying: “In the absence of these changes, Fannie and Freddie would be putting good money after bad and run the risk of further increasing the building epidemic of foreclosures and dysfunctional homeowner associations in Florida and around the country”.

I do always find it interesting that people who work for a buck and people who work for a vote often find themselves on different sides of the same issue.

Speaking about making a buck, it appears the top brass at Lennar (LEN) are pretty good at turning one, which is saying something in this market.  Back in 2006 and 2007 the company entered into a number of joint ventures which gave the other party in the deal at least 51% of the new entity.  The newly created JV then issued debt and purchased land that LEN had previously owned outright with LEN using the proceeds of the deal to pay down its own debt.  The JV debt was not required to be reflected on LEN’s balance sheet because the venture was not majority owned by LEN.  And you thought these guys just banged nails!

One of the more storied deals included Calpers (California Public Employees Retirement System) where Calpers put up $970MM to own 68% of a venture called LandSource.  The deal was struck in early 2007 and wound up going bust just 16 months later.  Calpers walked away from the table at that point but LEN hung on through bankruptcy and is now leading a group of new investors in an effort to take the entity out of Chapter 11, with the land in question being valued at just 18% of the original deal price.

LEN issued $400MM of a 12 ¼ coupon note maturing in June of 2017 back in April at 969.6bps over the associated Treasury.  The CDS spread in the 8 year area would have been about 350bps at the time so there was quite a premium required by the market place to take on this paper.  Having said that, when you can buy back land at less than 20% of what it used to cost you can probably afford to pay up to borrow the money to do the deal.

So, let’s see how these two examples compare to that little missive we saw in the window this past weekend.  Congress wants FNM and FRE to lessen lending standards which the vice chairman of CB Richard Ellis believes will create more of the “same” problems that we’re suffering through now.  LEN figured out how to get debt off its balance sheet and buy back property at pennies on the dollar, a little something “different” to say the least.

Maybe there is something to that saying after all.

Enjoy the week,

Jim Delaney

June 22, 2009

CDS spreads paused in their recent moon shot on Friday with the Hi-Yield index taking on just 7/10ths of a point or an increase of about 0.06% and the Investment Grade index falling 9/10^th of a point or 0.63%.  Small numbers yes, but in the context of a move from 926.2 on June 2^nd in the HY index to 1043.9 on Friday the small rate of change between the two days is worth noting.  The recent low in the IG index was 120.6 on June 5^th; with last Thursday’s close of 142.0 you can see there was an equally vicious rise in both indices.

To give you some perspective on this I am going to borrow from a recent missive put out by David Rosenberg, Chief Economist & Strategist for Gluskin Sheff in Toronto but whom you are probably familiar with from his days at Merrill Lynch.  David put a graphic in a recent piece that shows where Baa Corporate bond spreads were, in basis points, at the time of some notable economic events in America’s history.  Dave listed them chronologically but my point is a little different than his was so I sorted them in descending order with the widest one on top.  As mentioned all the numbers are in basis points.  (To prevent the blog from blowing up I’m doing this sans table.)

1932 Great Depression          724

2008 Credit Crunch          611

1975 Inflation/Recession Scare          413

2002 Enron/WorldCom Crisis          390

1937-1938 Depression Relapse          381

1982 Penn Square Bank Failure          377

2009 Right here, Right now          374

2001 9/11 Terrorist Attacks          353

1980-81 Recession/Lat Am. Crisis           329

1970 Recession          315

2001 Tech Wreck          306

1998 LTCM Crisis          277

1987 Stock Market Collapse          268

1990-91 Recession/Real Estate Crisis          239

1973 OPEC Embargo          221

1995 Tequila Crisis          180

1997 Asian Crisis          175

1962 Cuban Missile Crisis          113

Now that the numbers are posted here are the answers to some of the questions you might be asking:

There are 18 events in the list and the average spread is 335bps, the median spread is 322bps so they are not that far apart.

There is a 611bp range between the widest and the narrowest and where we are “Right here, Right now” is about 52% or a tad more than halfway to the top.

Keep in mind, as well, that this is not half way between the lows seen in 2006 and the highs of the Great Depression but halfway up a list of some if not “the” greatest economic disasters this country has ever faced.

I’m not sure there is any indication from this list as to where spreads will be this coming Friday but in historic context there were only six other times (per DR’s list) that spreads were wider than this.

One of the things this past crisis taught us is that when things get out of whack, they can get really, really out of whack.  As a “relative” calm returns it would seem that the probabilities favor a move towards narrower spreads.  As always, no promises, no guarantees and, as they say, trade the market you have, not the market you wish you had.

Enjoy the week,

Jim Delaney

June 19, 2009

The President, in his speech on Wednesday, outlined his plans for financial regulatory reform.  The raison d’etre of this effort, it would appear, is to prevent what just happened from happening again.  “Happened” might be a poor choice of words here as the world is still reeling from the effects of one of the greatest credit bubbles in its history but possibly more apropos when you consider that it is the elements of the disaster that the government expects to hinder in their constant effort to combine.  Those elements being risk taking and its consequences.

It is interesting to think that with the Federal Reserve, the Treasury’s Office of the Comptroller, the Office of Thrift Supervision, FDIC, National Credit Union Association, SEC and CFTC all in place there could be any more possible supervision but since I don’t work in Washington I’m obviously not in the know.

One of the main elements of the new plan gives the Federal Reserve the power to form a “regulatory regime” with standards set for the amount of capital, leverage and liquidity for any firm “who’s combination of size, leverage and interconnectedness could pose a threat to financial stability if it failed”.  The crux here is that should this situation arise, again, the Treasury is to be given the power to “stabilize it”.

Prior to Wednesday’s speech the market had a mechanism in place for firms that did not have enough capital and were overleveraged; it was called bankruptcy.  The new method will be to appoint a conservator or receiver to nurse the naughty company along.

By designating a financial institution too big, too leveraged and too interconnected the government is, in effect created a tiered market where those under its umbrella would gain competitive advantage through cheaper funding than a smaller firm not considered “too big to fail”.

This would in the end create what is known as an oligopoly which is defined as a market form in which a market or industry is dominated by a small number of participants.  If you need an example just cast your eyes towards Moscow.

A similar theme seems to be evolving among the nation’s power producers.  I’m not talking here about our Congress people I’m talking about Unistar Nuclear Energy, NRG Energy Corp, Scana Corp and Southern Co.  These four companies (the perfect size for an oligopoly) are expected to share a set of loan guarantees totaling $18.5BN to build the next generation of nuclear reactors.  For everyone that thinks electricity comes from a the light switch this would be “the biggest step in three decades and one that could vault the [named] utilities ahead of some of the sector’s strongest players”.

The “winners” were chosen from a list of seventeen companies that had applied for $122BN in federal loan guarantees.  The power generators represent a mix with SCG and SO being traditional utilities and NRG and Unistar (private) being what is known as “merchant” generators which means that they sell electricity at unregulated prices.  Merchant generators, it should be noted, are among those companies that will be most affected by the “Cap and Trade” program once the free permits the government is expected to hand out, run out.

The CDS/equity combination for NRG show the CDS hitting its highs on March 9^th and the stock bottoming two days later on March 11^th The numbers are 700bps and $16.34 respectively.  The stock retested those lows on April 28^th ($16.50) and the CDS made a slight move higher during the last half of May to 584bps after hitting and interim low of 500bps on May 6^th.  Since then the CDS has traded as low as 440bps and the stock as high as $24.37 on exactly the same day (June 12^th).  Last night’s close 484bps and $23.70.

SO’s CDS/equity combo looks very much different with an unusual degree of positive correlation between the two.  The highs in both markets were hit back January 2^nd of this year; 160bps/$37.47.  From there they both traded lower with the stock hitting its nadir on March 12^th at $26.81.  Since then the stock has traded within a range bounded by that low and a $31.82 high while the CDS has meandered down to a recent low of 61bps on June 15^th.

As mentioned Unistar is a private company and there are no CDS’s traded on Scana.

Enjoy the weekend, Comrade.

Jim Delaney

June 18, 2009

In days of old, when men were bold . . . err . . . better not go there; ok, let’s try this.

Trade has been an integral part of man’s existence since the caveman with the pelts gave some to the cave man with the fire so that they could both spend a leisurely evening reading by fireplace while Wilma and Betty went out to gather more wood, sporting the latest in outerwear, of course.

As things progressed and transportation improved to something you rode on and then in the circle of trading partners grew organically as accessibility increased.  For a long time most trade went on with those people and countries that were geographically closest to you.  Trade has existed for a very long time but export led economies are truly a 20^th century phenomenon.

With this in mind it was interesting to read some of what went on at the summit held this past weekend in Yekaterinberg, Russia, attended by Brazil, Russia, India and China or the BRIC countries as they are more commonly referred to.

The main result seems to have been the crafting of a statement which included the view that “The emerging and developing economies (especially the four of us) must have a greater voice and representation in international financial institutions.  There is a strong need for a stable, predictable and more diversified international monetary system.”

This, for all intent and purposes amounts to a knock on the USD which is interesting because before the meeting the Russian representative, Alexei Kudrin, was quoted as saying that his country had “full confidence” in the USD and that it was “too early to speak of an alternative” reserve currency.

The effect of all of this is that the market, in its own weird and wonderful way, keyed more on what Alexei said than the official statement from the BRIC-a-brac.  This gave pause to those who had been buying all things commodity related in hopes of the dollar’s demise.  Can you say schadenfreude? . . . Sure, I knew you could.

Lawrence Eagles, head of commodities research at J.P. Morgan Chase Bank was a little more sanguine saying, “there has been some profit taking going on,” when describing the recent pull back in commodities.

So, right about now you might be saying: I get all that but how does it relate to credit spreads.  I have asked myself that very same question about a million times since Monday rolled around and the market looked, once again, like it was on its way to hell in a hand basket.

I’m not saying this is the answer but my reasoning goes something like this.  Credit spreads are a combination of company specific as well as economy wide views on the credit environment.  Last week, eons ago I know, inflation was going to make the Weimar Republic look like a walk in Volkspark and interest rates were priced accordingly with the 10-year screeching towards the big 4.0.

When yields on Treasuries rise or fall quickly the instruments priced off of that curve do not react instantaneously.  Therefore, spreads will contract some when yields are rising and widen some when they fall.  This is not a permanent condition but more of a delayed reaction sort of thing that usually corrects itself within a few days.

In this latest instance this was represented in CDS land as narrowing spreads, which have had a tendency in the past of coinciding with higher stock price and which seemed to be following that script this time and causing yours truly to increase the number of long positions in the CEC Portfolio.

The subsequent falloff in UST yields, possibly as a result of demand for paper paying 4% when shorter term paper is trading in basis points or a glimmer of hope for the continued existence of the USD as per Mr. Kudrin, relieved some of the pressure in rates causing a widening in spreads which then resulted in the selling out a good portion of the long positions and increasing the number of short positions in the CEC Portfolio.

It has yet to be determined whether the move afoot is “the move” or as the gentleman from JPM said the result of “profit taking”.

I’ll be trying real hard to figure that out over the next few days and will be sure to let you know what I find.

Enjoy the week.

Jim Delaney

]]> http://www.marketstrategiesmgmt.com/2009/06/cmo-6182009/feed/ 0 http://www.marketstrategiesmgmt.com/2009/06/cmo-6172009/ http://www.marketstrategiesmgmt.com/2009/06/cmo-6172009/#comments Wed, 17 Jun 2009 10:50:44 +0000 Jim Delaney http://www.marketstrategiesmgmt.com/?p=377 Credit Market Overview

June 17, 2009

Last Wednesday I wrote about the overall tendency for stocks to move in unison with correlation running near 80% between a given stock and the S&P index.  I don’t have any exact figures for you this morning as to how much that has changed, if any, from a purely quantitative standpoint but from executing the most trades that I have in the CEC Portfolio in quite sometime I can tell you it sure feels different.

In Monday’s comment I wrote that CDS spreads had made new lows for the move the previous Friday.  This was corroborated by the number of longs vs. shorts in the portfolio as well as the distribution of those longs across many sectors; all giving credence to 80% correlation figure.

Spreads since have definitely changed direction and it has been painful to watch positions, only recently established and seeming to have such potential late last week, get cut as the as the horse hair broke and the sword came down on Damocles (played in this episode by the S&P).

Getting caught in the downdraft has not been fun but the emergence of the variation in movement among the sectors has been encouraging as it is in an environment where multiple forces are at play that the CEC Strategy does well.

Knowing that the driver of all decision in the Strategy is CDS movement I thought it might be interesting to see what longs still exist after two full days of pruning and in what sectors the shorts are accumulating.  No recommendations here, just giving you a look over the shoulder.  To put this in some perspective for you the number of longs at the end of last week was 146 vs. 40 short positions for a total exposure to the market of 44%.  You can see last night’s numbers at the top of the page.

Before you get to the actual numbers a quick explanation, the first number is a percentage as it shows the net of the longs and shorts in a sector divided by the number of names I track in that sector, the second number (on the other side of the “/”) is the total number of names I track in that sector which should give you a better idea of its representation in the entire Portfolio.

For example, out of 16 names I track in Finance there is a 19% net positive delta out of 21 names tracked.  Insurance -4% out of 25 names; Homebuilders -45%/14 names; Healthcare -15%/13; Drilling 67%/6; Electric-Integrated 48%/27; Power 50%/4; Refining & Marketing -67%/3; Oil Service 100%/4; Oil-Composite 35%/17; Pipeline 64%/11; REITs -5%/21; Transportation -8%/12; Cruiselines -100%/2; Metals 57%/7; Industrials 11%/18; Consumer 30%/37; Pharma -14%/14; Retail -8%/26; Communication 6%/17; Technology 43%/21; Defense 43%/7.

The take away here is that, for now, it appears the commodity names (energy, metals) along with technology and are still holding up fairly well while those things housing related and the discretionary side of the consumer space are not.

Most importantly, if this portends a move away from 80% correlation, that would be very good news indeed.

Enjoy the week.

Jim Delaney

June 16, 2009

When someone is on life support the discussion regarding whether or not to remove them portends something very bad or reasonably good.  The world’s financial markets were in a very bad way for all of last year and most of the 1^st quarter of 2009.  Since then ample media attention has been paid to signs that things might be stabilizing.  Banks raising capital in the debt and equity markets without explicit government guarantees (unfortunately, the implicit guarantee is now a fixture) and the back half of the BRIC nations reporting positive GDP growth; 5.8% for India and 6.1% for China

Going into this past weekend’s G-8 meeting there were reports in the media that the discussions of exit strategies from the various stimulus efforts were at least one of the topics that would be discussed during the confab.

Germany, ever mindful of the ravages of inflation, was the most hawkish going into the meeting with their central bank head, Axel Weber, saying “Raising interest-rates levels as a precaution certainly is a challenge from a communication point of view, but one that can be mastered”.  Luxembourg’s, central bank governor, Yves Mersch, sided with Axel suggesting that while he “was inclined to let the bank’s (ECB) recent cuts sink in”.  He also stated that “It’s not enough to have elements of an exit strategy for each instrument, you need a comprehensive picture.  And after having done what was needed to be done, we are now trying to get a more comprehensive picture.”

With these statements being made well in advance of the weekend’s meeting it seemed at least a little strange that the market would sell off beginning in Asia and continuing around the world yesterday.  One would have thought that a consensus by the world’s leading central bankers that things are improving enough that they could actually begin to consider how to remove their meddling fingers from the markets would have been something the markets would be all to happy to hear.  One has to wonder whether it will be considered such after some deliberation.

It seems akin to that day when the training wheels are taken off and you move on to riding on two wheels and not four.  In the end you know it’s going to be good; it’s just that getting there is a little scary.

The sovereign CDS level for Germany peaked at 92bps on February 24^th of this year and fell most recently to a low of 23bps on May 11^th.  It closed yesterday at 35bps.  America’s CDS’s also peaked on 2/24 but at 100bps and then got as low as 26bps on 5/12 following a similar path, with regard to peaks and valleys, as Germany’s CDS’s.

Prior to 2008 the U.S. CDS level hovered around the 8bps level while Germany’s fluctuated between 2bps and 13bps.

Enjoy the week.

Jim Delaney