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The S&P cash made new lows for the year as we aggressively probed lower into the close and penetrated Doug Kass's bottom from Aug 9th with cash and futures closing below 1100 back to 13 month lows, with the pain spreading wide following rumors of hedge fund blow ups. Financials led the dance and just could not get a break all day despite the early perfectly fadable cheerleading from Cramer et al.
Credit markets were a disaster with red everywhere and notable gaps suggesting some desperate reaching for hedges/unwinds as index overlays started to disengage from single-names. IG closed over 5bps wider at 149.5bps (while underlyings popped notably more) and HY cracked 50bps wider to around 900bps! Tail names were crushed as IG9 (the short-dated but most exposed to high tail risk and correlation traders) widened 14bps to 164bps and CMBX and ABX tranche prices all blew lower with seniors underperforming juniors (which represents more long correlation/systemic risk bets).
Source: CMA
We have warned that sooner or later, managers/traders will need to sell/unwind longs as basis risk in the hedges/overlays becomes too much and the moves today suggest we are getting there (especially in financials) as it was the widest names in IG that cracked the most ( absolutely) even as low beta credits hugely underperformed relatively as traders grabbed at whatever was low cost protection with some market exposure (e.g. insurers). Insurers have been one of the best low cost long vol trades of the year as buying protection on a basket versus IG was very low carry and had excellent beta to HY (as these names are basically over-stuffed HY new issue soaks - they need the yield).
We have discussed the financials extensively today but while the chart and table above shows both stocks and credit getting sold aggressively, we thought it worth noting options activity and the front-end of the CDS curve. While counterparty risk is obviously significant (what else is a major trading partner to do when he sees this kind of market action?) the moves in the 1Y CDS today were dramatic in MS (and the other TBTFs to some extent). We opened 580/630, pushed wider, then flattened at 640/690 for much of the day until the last hour or so when the offer side got lifted aggressively to 650/725. At the same time volume in OTM puts was very large with $5 strikes most notably. While the stock and CDS weakened very significantly into the close, the $5 strike puts did not continue to push too much higher from their midday levels. The point is that we suspect with implied vols north of 200%, that capital structure arbs were in play, selling 'expensive' equity puts and buying 'cheap' protection (we discussed this rather complex idea a few times in the past - most notably here). We bring this up as it helps explain the moves at the front-end of the curve but while this may reduce some fear, the action in bonds and the rest of the credit-equity complex were horrible.
TSYs saw an enormous day as 'Twist' started with 30Y -19bps and 10Y -17bps and both investment grade and high yield bonds were net sold - something we have not seen for a while. Financials were the most net-sold corporate bonds (didn't we warn that the buying last week was basis traders and not 'real' money?) followed by Communications names. What was also worrisome - but in line with the huge flattening in TSYs - was the rush to net sell anything with duration/risk as 3year and above maturities were net-sold while 0-1Y was the most net-bought on the day
Instead of its normal sideways plod after Europe closes, FX
markets continued to weaken dramatically against the USD with only JPY holding stronger while EUR broke to a 1.31 handle and closed at its lows of the day as DXY managed to trade at its highest since Jan 13th 2011. Gold and Silver managed decent gains (the former outperforming the latter) as oil and copper lost 2-3% on the day.
As we closed broad risk assets (CONTEXT) and the S&P managed to reconnect - with ES overshooting a little after cash closed. While relative to credit we still see 20-30pts of downside for the S&P (based on current HY levels which obviously can deteriorate), we need to see further weakness in carry FX and oil as well as strength and flattening in TSYs (more 2s10s30s compression) to really 'enable' this sell-off to reach Janjuah levels - but given the momentum into the close, nothing would surprise us.
Charts: Bloomberg
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