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IG credit spreads broke above their 200DMA

HY credit spreads broke above their 200DMA

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Each time rolling HY-IG beta has dropped below 3x, we have seen notable decompression.

HY-IG differential at six month wides. Interesting that demand not stepped back in given multiple expansion of last few months in HY over IG ratio.

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HY realized vol finally breaking upwards will tend to reduce appetite further from reach-foryield perspective.

We warned of risk appetite changes in Match and switched to outright negative in April. Dramatically more downside in credit still just from QE2.

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We warned of a rising dispersion in HY in Q1 as investors stopped buying everything. Discrimination has picked up and now is reaching IG also.

HY curves were very steep anyway. Hedging recently has over-extended the 5Y alone and last week or so we saw major flattening as 3Y underperformed crowded trade!

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The preferred trade for HY derisking was Short IG Insurers relative to IG corporates. This is working very well as Insurers are nothing more than levered portfolios of HY debt.

One unique insight is the shift in internal correlations among index components. We warned when we saw HY rise notably and now equity and IG credit has joined it as systemic selling is under way.

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The credit market (both IG and HY) trade cheap to equity/vol implied levels credit anticipates and equity confirms credit is leading the way.

We strongly suggested that we would see HY realized vol rising quicker than S&P 500 realized vol. This highly meanreverting relationship is playing out as we expected.
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Credit Market Performance since 5/31 3Y close.
IG16 5Y
99.81 +10.31 96.13 +7.97 110.38 +7.88 114.55 +9.53 408.75 +38.75 397.77 +42.22 506.26 +59.80 487.23 +58.65 230.00 +33.50 223.19 +31.02 134.45 +11.35 126.08 +12.50 56.98 +4.93 46.78 +5.81 114.98 +17.90 113.19 +17.30 172.63 +15.88 171.96 +20.26 62.25 +8.00 57.42 +10.73 160.75 +21.75 159.12 +20.72 305.50 +46.00 290.92 +43.72 179.87 +14.48 178.80 +15.95 54.09 +6.28 49.49 +7.06 180.21 +20.62 179.05 +19.08 185.28 +12.56 188.77 +16.17 48.78 +4.62 47.99 +7.15 194.08 +20.70 193.13 +18.59

7Y
114.52 +6.33 119.49 +7.36 125.78 +8.20 129.32 +8.89 436.80 +36.79 427.95 +41.91

10Y
128.67 +5.93 135.58 +6.54 136.51 +7.94 140.78 +9.02 448.69 +35.46 440.67 +40.70

IG Cheap to FV in 3Y & 5Y, Rich to 7Y & 10Y

Main15

Main FV cheap due to FINLs

XOver15

HY16

3Y underperformed relatively
SovX

FINLs

FINLs-Main

HiVol15

FINSUB

Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg Index Chg FV Chg

61.30 +5.77 56.03 +5.30 77.47 +6.42 79.30 +6.69 298.34 +27.29 289.11 +29.91 367.98 +55.98 353.39 +44.17

SovX liquidity premium

FIN Sub index liquidity premium

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Capital Context LLC, 2011

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Contextual Cycle is reverting back to fair-value.

Last week saw Consumer Staples diverge from fair-value but Materials and Healthcare converge.

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Financials equities underperforming credit the most. Energy credits outperforming equities the most in the last week.

Less credit underperformance as we move up in quality. Equity underperforming credit. Bottomline -> Up-In-Quality and Up-In-Capital-Structure preference is very clear recently.

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Normalized performance of credit and equities last week. Utilities and Capital Goods stand out.

The normalized Volatility performance relative to Credit notice how much better behaved this is than stocks Vol is rising and will continue to do so as it was low relative to credit anyway.
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The change in implied vol rises very notably across quality and as the relative credit performance (x-axis) over stocks.

Financial Systemic Risk near oneyear highs. +100% from Q4/09 lows
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US and European risk rising rapidly relative to Asian bank risk.

US bank CDS starting to catch up to US bank bond spreads and equities not a good sign at all!
www.capitalcontext.com @capitalcontext Capital Context LLC, 2011