Monday November 21

Stocks rallied today as each of the four US equity indices hit record highs. The S&P 500 rose 0.8% to 2,198 and the Dow Jones rose 0.5% to 18,956. Utilities rose 1.1% while the KBW Bank index rose 0.2%. The VIX continues to fall down 5.1% today to 12.2. The two year yield rose 2bp to 1.08% and the ten year yield was flat at 2.32%. In FX markets the dollar was weaker against most peers. USD fell 0.4% against EUR to $1.0629. USD fell 0.1% against JPY to Y110.83. USD fell 1.2% against GBP to $1.2491. In commodity markets WTI rose 4% to $47.48. Brent rose 4.8% to $49.13. Oil prices were higher as Putin came across optimistic on an Opec deal, as well as similar comments from Iran’s oil minister. The market for Fed funds futures currently reflects a 95% chance of higher rates in December.

Small cap stocks have outperformed after the election. The Russell 2000 is up 10% since the election outcome whereas the S&P 500 is up just 2%. Small caps tend to earn a majority of their revenues domestically, which is an advantageous characteristic given Trump’s expected policies. Investors also expect that Trump and the Republican Congress will be pro-business through deregulation and lower taxes. Protectionist policies, tax breaks, and deregulation also disproportionately benefit smaller companies relative to larger ones. Year to date small caps are up over 6%. They carry a much smaller market cap and tend to be more volatile than large caps. Within small caps, sector outperformance has for the most part mimicked sector performance within the S&P 500.

Junk bond spreads have held steady since Trump’s election victory, which is a slightly reassuring sign for the sector. Even as yields on more secure debt such as Treasuries have been on the rise, the risk premium on high yield has not widened substantially. At the same time several companies have come to market with issuances which is a sign of relative health and demand in the market. Weatherford International’s $540mm issuance last week was bumped from a planned $500mm size, even though Fitch gave the issue a CCC rating which is four grades lower than the previous rating. Since the election companies that carry non-investment grade ratings have issued more than $5bn in debt. This comes even as high yield bonds have experienced outflows for the past three weeks. In the three weeks before November 16 investors took $7.1bn out of the sector. That suggests that fund managers had been sitting on the sideline waiting for opportunities to invest, possibly waiting for yields to rise and present a buying opportunity. Yields have backed up from 6.74% currently compared to 6.42% before the election. The spread to UST has tightened slightly from +517 to +510. Although spreads are not at their pre election trough in the high +400s, they have resumed downward momentum. Corporate bonds in general have lost since the election on a total return basis. Investment grade debt is down 2.55%, BB debt is down 1.4% and CCC debt is down less than 0.1%. Riskier companies are less exposed to rising Treasury yields relative to less risky companies. This indicates that companies worse on the credit spectrum, lower rated companies, are outperforming. So far the sector is up 14.1% this year likely due to the search for yield that’s affecting different asset classes.

Derivatives market participants are paying close attention to Trump’s statements regarding financial deregulation. A large portion of Dodd-Frank is meant to contain risk in the OTC derivatives market, and many industry officials like those portions of the law. Rules meant that plain-vanilla swaps had to be executed on certain marketplaces which pushed a portion of the market to central clearing houses. Consequently the positions were reported to regulators. Title 7 of Dodd-Frank is the portion that pertains to the derivatives market, and the current chairman of the CFTC supports that part of the law and says there is a general consensus of support there. Some think it would be too much to entirely scale back the law. Additionally there would be a cost for the banks to remove all of the controls they put in place in order to accomodate Dodd-Frank in the first place. On a somewhat related note after the Brexit clearing houses demanded additional collateral from traders and investors to protect themselves against volatility and large swings in the market. On June 24, data from the CFTC showed that the largest clearing houses called for $27bn in additional capital. Clearing houses take collateral to protect themselves against losses if a certain counterparty to a derivative defaults.

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Monday November 21

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