• GB Davis

Quadruple Witching Expiration Friday to End with a 30 VIX and No Violence - 6/19/20

Risk Markets looking pretty tame on this Quadruple Witching Expiration Friday - despite elevated VIX.  The massive volatility many expected into quarter end (in options expiration terms) failed to materialize - and is unlikely to do so today.  That's not to say we are out of the "woods": checking in on credit, top-down. Some Excerpts from Moody's (w/ a Fitch comp thrown in).

  • The costs from the COVID-19 pandemic are rising by the day. With the U.S., India and Russia recording sharp increases in new cases, China now facing new risks from a second wave of infections, and geopolitical tensions between the U.S. and China, external conditions remain challenging and will weigh more heavily on global trade in the months ahead. Internal risks may also increase unless the health crisis is fully controlled and consumer confidence improves  

  • The aging of the U.S. population and workforce, as well as average annual labor force growth of between 0.3% and 0.5% during the next 10 years will make it all but impossible to sustain economic growth at a rate materially above 2%, unless the average annual rate of labor productivity growth well exceeds its 1.2% rise of the 10-years-ended 2019. 

  • U.S. corporate credit quality continues to deteriorate as a result of the global recession.   

  • As measured by Moody's long-term average corporate bond yield, the recent investment grade corporate bond yield spread of 148 basis points far exceeded its 122-point mean of the two previous economic recoveries [inference, we are not likely in a recovery here]

  • After growing by 87% annually during 2020’s first half, US$-denominated bond offerings may dip by 5% annually during the second [half of 2020]

  • An unfolding global recession will rein in Treasury bond yields. As long as the global economy operates below trend, 1.25% will serve as the upper bound for the 10-year Treasury yield. Until COVID-19 risks fade, substantially wider credit spreads are possible.   

  • Moody’s Investors Service expects the global loan-only default rate of high-yield issuers to rise from May 2020’s 5.1% to a January 2021 peak of 12.1%, while the bond-only default rate climbs up from May 2020’s 4.1% to a February 2021 peak of 8.3%. Meanwhile the global default rate for high-yield issuers of both bonds and loans is projected to increase from May 2020’s 7.1% to a 11.1% top by March 2021.  

  • Fitch Ratings expects the coronavirus pandemic to put significant and long-lasting pressure on U.S. speculative-grade corporates. Given considerable uncertainty as to the severity and length of the crisis, Fitch has defined firm-wide baseline and downside views that supplement our bottom-up approach and help to inform our U.S. institutional leveraged loan and high-yield default rate forecasts through 2021. With yoy default activity notably already up, our base case forecast is for a roughly 15% two-year cumulative default rate between 2020 and 2021 for both loans and bonds. However, in a severe scenario the cumulative rate could reach 25%, exceeding the 21% cumulative high-yield bond default rate seen in 2008–2009. A wave of fallen angels has driven the HY market size to $1.34 trillion from $1.16 trillion at YE 2019. This will to some extend counteract the rise in default volume for the HY market, lowering the default rate from what it would have been holding the universe constant  High Risk Sectors: Airlines; Auto Suppliers; Gaming; Lodging & Leisure; Metals & Mining; Non-Food Retail; Oil & Gas; Restaurants.  It’s important to note that the eventual recovery will most likely be uneven across and within sectors. Some companies will gain market share from rivals or emerge with more flexible cost structures and diversified revenue streams. Furthermore, a rebound in economic activity does not mean that a prolonged period of elevated default activity will not occur. We expect bankruptcies and DDEs to continue throughout the recovery.  In general, we believe that some recovery rates for defaulters during the crisis will be well below long-term average levels as there is an inverse relationship between default volume and recovery rates and significant uncertainty as to the length and severity of the downturn. The trajectory and timing of the rebound, along with availability of corporate liquidity, will be driving factors related to average loan and bond recovery rates achieved during this stress period.

  • the composite high-yield bond spread’s recent five-day average of 635 bp is surprisingly narrow given the prospective 30.2% net high-yield downgrade ratio of the six-months-ended June 2020. Statistically speaking, the latest net high-yield downgrade ratio has been associated with a 1,250 bp midpoint for the high-yield bond spread. Moreover, when the net high-yield downgrade rose to a recordhigh 32.8% for the span-ended March 2009, first-quarter 2009’s high-yield bond spread averaged 1,604 bp

  • The now very wide gap between the high-yield bond spread predicted by net high-yield downgrades less the actual high-yield spread warns of a wider high-yield bond spread by the second quarter of 2021. for 65% of the 20 observations showing at least a 114 bp difference between the high-yield bond spread predicted by net high-yield downgrades less the actual high-yield spread, the high-yield spread was wider a year later 

  • newly rated loans from high-yield issuers are now on track to plunge 58% annually for the second quarter. To a considerable degree, newly offered high-yield bonds now refinance outstanding loans.     

  • Our view is that the euro zone’s manufacturing PMI rose to 48 in June from 39.4 in May. We expect that both domestic and foreign orders remained subdued, with the plunge in global trade keeping a lid on the performance of the euro zone’s export sector. Prospects for exports remain weak, especially as the pandemic still hasn’t peaked in some parts of the globe, while a second wave of the virus is happening in others (notably China), which is resulting in reimposed restrictions. Given that the euro zone is an extremely export-dependent economy, we expect that any rebound in its manufacturing industry will remain contained by the weak performance of foreign trade during the rest of this year. This is true especially for Germany, which exports an outsized share of its GDP—mainly to China and the U.S  

  • The Bank of England delivered what markets were expecting in June—raising quantitative easing by £100 billion to a total of £745 billion—but the meeting struck a rather hawkish tone  Despite these hawkish turns, we maintain our forecast that the bank will need to announce more QE purchases before the end of the year.   [we made the same comment regarding the need for me, yesterday]

  • As things stand, downside risks for Japan from a potential second wave of infections and the uncertainty in external demand remain elevated, and a deep recession in 2020 is imminent. [we relayed that JPN has the worst macro prospects of any developed nation]

U.S. Steel ($X) which we successfully shorted recently; preannounced a terrible 2Q Outlook - we think next week's earnings for $WOR will be terrible and are short.  CDS on $X also blowing out, up over 150bps to near 1300 in just one week.

Have a good Friday and weekend, GBD

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