Thursday January 12

Stocks fell as investors digest Trump’s press conference yesterday and prepare for him to take office at the end of next week. The S&P 500 fell 0.2% to 2,270 and the Dow Jones fell 0.3% to 19,891. The KBW Bank index fell 1% while utilities rose marginally. Economic data today showed that jobless claims came in at a very low 247k which was below consensus. Additionally import prices rose 0.4% on the month which was below consensus and export prices were slightly higher than consensus. Charles Evans spoke today and said that fiscal stimulus could lead him and the Fed to push up their growth forecasts. The two year Treasury yield today fell to 1.18%. The ten year Treasury yield fell to 2.36%. Accordingly 2yr vs 10yr finished at 1.19%. The dollar was weaker across the board today with the exception being the British pound. USD fell 0.3% against EUR to $1.0612. USD fell 0.6% against JPY to Y114.76. USD rose 0.4% against GBP to $1.2165. Oil prices rose sharply for the second day in a row. WTI rose 1.5% to $53.03 and Brent rose 1.7% to $56.06 even in spite of bearish data that came out yesterday.

Pricing in options markets suggests that traders expect volatility surrounding bank earnings this time around in addition to some bearishness. On average markets typically price in implied volatility between 1 and 2% around the release of earnings for the largest American banks. This time around they expect volatility to range between 2.5% and 4%. Additionally over the last few weeks open interest in put contracts on financial sector ETFs have increased by 26% while open interest for puts has risen only 8.6%. However option skew (the difference in price between puts and calls) is still low compared to its 52 week range. That suggests that the cost of insuring against losses is still relatively low. This behavior in options markets may be a function of the fact that financials have performed very well since the election rallying 18%. Some analysts believe this may be overdone, and that it is a crowded trade vulnerable for a correction.

Covenants given to bond investors have been getting weaker and weaker which is an example of how market factors are changing the underpinnings of financial products. Typically investors receive certain cash premiums if the issuer breaks through certain thresholds on pre-specified metrics. Covenants can include certain credit or leverage ratios, if dividends are paid above a certain level, or if the bond is called early. However over the past few months bonds have been sold in which these covenants are absent from the legal documents. This includes some emerging market bond issuances in countries such as Brazil as well as more established corporate issuers such as FedEx. Investors for good reason don’t like this new development and they have threatened to not participate in deals that are missing those covenants. For example Novolex, a portfolio company of Carlyle, had to change to include those covenants in a $625mm issuance after investors said they weren’t going to participate without it. Some analysts argue that this weakens investors protections and that this is a bad thing, however it is just a natural development that gives preference to the borrower given how desperate investors are for yield.

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Thursday January 12

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