Keeping The Faith

Everyone seems to look out for relationships between different indices, currencies especially in times of stress. An interesting one is Gold and USD which has broken down from their historically inverse relationship and remains very near neutral over the short term. Gold has consistently been touted as an excellent store of value especially during market volatility (though no one can actually explain to me why Gold, which has 0 positive carry, does not have significant use apart from the proverbial Indian wedding and is valued against currency thereby negating its non-inflationary value, can withstand duress better than paper currency). The fact that the short term relationship between USD and Gold is market neutral, signifies that both carry equally important significance with investors. This is especially significant when it comes to the currency market, particularly since it would mean that with investors adapting the mantra in the Dollar we trust, we may well see a consistent strengthening of the Dollar over the year, particularly against £ (one of my favourite plays) and  €.

The over whelming feel of the traders has been that this broader market rally has been one sustained and brutal bear rally (brutal given the way most of the Street is positioned), within the Credit space. In Mortgage-Backed space, it was assumed that a number of the underlying credit were worth 0, particularly given the pace of defaults within Commercial and Residential pace. However, now that the shorts are trying to come out of their positions, they are finding there’s no one to take the other side of the trade, with clear out performance of the most shorted ABS indices in the last month. To give an example  in spite underlying collateral deterioration, AAA and BBB in CMBX are trading just under their 2008 levels. It just goes to show that the market momentum has carried on for far too long and it may well be time for investors to continue holding through the pain barrier (if they can afford it) or for new investors who missed out on the initial fall in market, to re position themselves by going short now.

Its heartening to see Trichet claim that the global economy is close to a turning point; its fascinating the extent to which sentiment is surging through. Virtually all asset classes have been rallying particularly in abs space, where across the asset class tranches have seen a return of buyer interest. Furthermore in CLO space there seems to be an increasing belief that corporate defaults have already been priced in and that therefore AAA & AA loans are severely undervalued; with most AAAs having NAVs (net asset values) of above 95%. However I still feel that the pickup in corporate defaults is the last phase of the recession market cycle and is going to pose a greater threat.

The other quietening fear is that confidence in governments evaporates however because of increased global coordination that’s starting to looking (thankfully) unlikely; if there is such a collapse, then the systemic failure will render us all bankrupt (except the gold bugs of course). Despite the BoE’s announcements of a further £50bn in the size of the bond auction scheme that the market didn’t seem to really seem to respond; there seems to be an extra latitude given to such institutions to “get on with their jobs”. Furthermore the ECB has finally decided to start supporting the covered bond market, a 60bn Euro scheme in an estimated 2.7trn Euro market. Nevertheless its precisely these schemes that are going to lay the foundation for a functioning credit market and one that will probably be more resilient in the future; it’d be a pity and waste of time if we’d have to relearn these lessons in the next market cycle.

In new issuance space; there’s been 14bn Euro of corporate issuance over the last four days, which probably will bring liquidity relief to major European corporates. We’ve had auto, utility, pharma and energy companies issue bonds in the immediate aftermath of the earning season; however what’s been interesting as well is the commensurate reduction in new issue premium by around 50bps across similar maturity issues and also the overwhelming demand by investors; book sizes being multiples of 5 or more of issue size.