The T Report: Rock-a-bye Baby

Getting Lulled to Sleep

After last week’s strong close the market has been able to creep higher. S&P futures actually hit a new high overnight, we are lower now, but that is worth watching. VIX is also at a multi-week low, and I’m told by some people much smarter than me, that the term structure is also very flat.

So are we consolidating and getting ready break higher, or is this the calm before the storm? That is the question we are all wrestling with.

The bear case remains obvious: weak economies, weak earnings, feeble responses from central banks that don’t work anyways.

The bull case is that Europe is finally turning the corner in terms of aggressive response, and while it won’t fix anything, it gives them time to fix things. The economy has been so battered and expectations so low that it won’t take much more than the proverbial “green shoots” to spark a risk on trade. Risk aversion is highlighted by the negative and low yields. The one point that we harp on more than anyone else, is that the yields are in part due to hopes of gains from a currency redenomination. There is some greed built into those low yields, and if Draghi is able to convince the markets that a Euro break-up isn’t coming any time soon, then that is a lot of money that can come into the markets.

The market will continue to move whenever Rajoy opens his mouth and says something that doesn’t appear to be begging for money, but the reaction will be muted. We are not betting on Rajoy being a smart, energetic, creative leader, we are just betting on him being more practical than a rabid dog.

The market will continue to move whenever Germany appears to say “Nein”, but Germany will not say nein as they too have finally realized that a Euro break-up is complex and will hurt the German economy. For all their talk about a “Europe” deep down they are worried about their own economies, and the realization that bailouts (which so far are just below market loans rather than any real “gifts”) are as important to the German economy as they are to the periphery.

You CANNOT source good bonds. The high yield bond market remains very strong. There are fluctuations in the ETFs and even in the CDS, but the market remains strong. New issues are in high demand. Look for a reach for yield to occur, story credits and illiquid bonds will become all the rage. I also think selling high beta CDS makes the most sense if you can do it.

I still remain convinced that HY18 and IG18 will cross where they both trade at the same “price”. This view that credit still has room to run is supportive for risk to me. So I remain long and have been adding on dips and selling back on peaks. Focus has remained Spain and banks. I continue to watch the S&P 1,350 September puts which closed at 12.50 yesterday and will likely open lower again today.

Now I have to get back to vacation, sorry for the brevity and lateness of this morning’s note.