How To Play The Sovereign Lehman In Credit
Courtesy of Tyler Durden
There is no question now that the complacency about Greece and the peripheral European implosion is identical to the Bear->Lehman->Financial collapse pathway that the US experienced between March and September 2008. And just like back then Bear was small enough to bail out, soon we will hit a country that not even the IMF’s half a trillion rescue facility will be sufficiently large to prevent from teetering over. At this point it is nothing but a waiting game. However, unlike the US, when after Lehman the Fed scrambled to throw $24 trillion of Fed signed paper at the fire, expecting a comparable coordinated and rapid response from the Eurozone is ludicrous, especially with Goldman shorting it. So those who believe they can time the market melt up until the next unsustainable sovereign blow up - good luck (of course here we refer to the daytraders who take their guidance from the Momo Money brigade, whose refrain for 60 minutes each day is “it will go up because it is going up.” Brilliant). For everyone else, we present a short primer from UBS on how to play the sovereign crisis, at least until the point when playing anything is futile and the global scramble for cash crashes the Keynesian dream.
From UBS:
The heighted spread volatility, low trading volumes and seemingly endless negative sovereign headlines have reminded us of 2H08. How will the problems in the sovereign market affect credit? On Chart 1 on the next page, we identify six possible implications for credit.
Short-term implications:
(1) Flight to quality to continue – Price action this week suggests that negative news have yet to be fully priced in. We expect further rotation out of senior financials and peripheral sovereigns into AA/A corporates. Other “safe assets” such as US Treasury, bunds and gold will probably also benefit form the “safe haven” rotation.
Long-term implications:
(1) Bifurcating market to persist – While correlation across asset classes (credit, equities, commodities, FX) will rise in the short-term, the widening may represent an attractive opportunity to buy IG non-financials and HY credits, which should continue to benefit from favourable earnings, ongoing inflows and a light new issue calendar
(2) Low rates for longer – Rising government bond yields will make deficit reductions even more challenging. ECB may keep policy rates at depressed level to offset the negative impact of lower fiscal spending. Ironically, lower short-term rates will likely be positive for credit.
(3) Strategic M&A to rise – More IG companies may look for bolt-on acquisition opportunities in the absence of organic growth. Cross-border M&A may rise given a weak Euro. We expect BB/B companies to be the primary beneficiaries.
(4) Cyclicals to lose steam – BBB cyclical companies have benefited from the ongoing search for yields. These credits may become more vulnerable if fear of slower growth emerges. We think the HVOL index represents a cheap short.
(5) Fade the news and sell volatility – Implied volatility in the credit market will rise on the back of negative sovereign headlines. We generally prefer to fade the news and look for opportunity to sell vol.
Of course, with UBS desperately seeking to regain some of its long-lost bond trading lustre, it is no surprise that just like Europe suggests to fix a debt problem by piling on more debt, so UBS recommends resolving a long-risk danger by going even longer risk. Oh well.
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