Link to PDFThe credit markets have gone on quite a ride with the late summer credit crunch following the spade of sub-prime defaults, and now the recent push back by the Fed. The 50bp cut by the Fed was at the high end of expectations (25bp – 50bp) and with Bernake a proponent of ‘data-driven’ decisions, the signal can be interpreted that the US economy may have some deeper causes for worry.
The markets though are still buoyant, displaying to an extent confidence that the worst-case scenario is a mid-cycle flattening. Secondary markets and increased depth in synthetic and bespoke products have also provided the added benefit of risk dispersion.
The key to capturing alpha as we move into 4Q is a return to fundamentals. Across the board, liquidity is still ample and risk appetite is still high, as investors who pulled out in the wake of the sub-prime fallout are wading back into the markets. A hallmark of the markets in recent years has been overabundant liquidity which has mitigated risk premiums. However as liquidity becomes ‘smart money’ and investors demand less beta for the same alpha there will need to be more transparency in the markets with regard to risk.
It is in this re-pricing of risk that the opportunity to search, identify, and capture profit lies. The markets as a whole saw spread widening as a result of the sub-prime crunch. Bernake’s move which echoed the ‘Greenspan put’ in some investors eyes, has given the markets a second wind, but one where the tailwind is not across all markets.
The opportunity and challenge is to re-construct the risk-reward matrix to cherry-pick the names which have been over sold and the names which are best positioned for the new market environment moving forward.
With the volatility in the markets, there are a number of opportunities to enter into positive risk/reward positions. Depending on
In the near term – look for refinancings in cp for good purchase opportunites as the general credit malaise will force an undue risk premia on fundamentally sound credit risks.
With the yield curve normalizing and beginning to steepen, TIPS/Treas plays across the 2s and 10s should offer good entry points for either short duration or long duration theta plays. The liquidity premium for short term swaps may be capping off, but the short end of the curve remains the best play for liquidity and steepening.
In the CDO/CLO markets, there should be good opps in the mezz and super senior tranches. Selling protection on mezz tranches for a directional view or better yet scouring the Synthetic CLO space for opps as Synthetic CLOs should start to outpace the recent run by cash clo’s due to their quicker ramp up time and bullet structure.
The financing environment has been getting more active, but the leveraged loan pipeline is flush with commitments that need placing, so LBO activity should see a dip while leveraged re-financings ramp up.
The CDX and LCDS rolls introduced new names and overall a bit more volatility and leverage. The HY CDX has been trading in lockstep with the LCDS so it’ll be interesting to examine the overlapping/non-overlapping names to see if any widening delta-neutral trades are there.
The IG space is good for defejavascript:void(0)
Publish Postnsive postioning, screening for names by fundamentals is key, with particular focus on non-cyclicals, w/ low comparable leverage, high ratio of foreign revenues, and low beta.
Generally, short duration (<=5 yr), early carry in the senior equity space is a prudent approach to take on risk with a marginal downside in a flat to bullish credit environment.
Labels: Credit, Fed, Macro, US
