"Perhaps there is a point at which credulity firmly and calmly and irrevocably declines..."
'The Unvanquished', William Faulkner
The S&P has tested its long-term support level twice in the past two days and both times the floor has held. The benchmark index is showing some fight at this level but as a new set of market factors emerge, the question becomes whether they will lead to a recovery rally or be the proverbial straw that breaks the market's back.
DROPPING DOLLARS, COCO BONDS AND THE MANIFESTATION OF EQUITY RISK
I recently wrote a post titled 'The Death of the Dollar Rally and Why It Matters':
http://tancockstradingblog.blogspot.com/2016/02/the-death-of-dollar-rally-and-why-it.html
The premise of the blog is that a combination of market weakness and slowing global growth are changing expectations for future domestic interest rate policy and adversely affecting the long-mighty U.S. Dollar. In spite of a healthy jobs report last Friday, the dollar's downtrend appears to be picking up steam:
As a result, stocks' of import reliant companies have gotten badly bruised while natural resources (namely metals and mining) are coming to life. A weak dollar is typically bullish for equity markets but - for the time being - buyers are choosing to stay on the sidelines instead of seeking out value.
Perhaps more troubling to the market is the rising possibility of a major credit event, the likes of which has not been seen since 2008. Deutsche Bank is actively fending off speculation that it won't be able to meet its coupon obligations on a series of subordinated debt called CoCo bonds. 'CoCo' is short for Conditional Convertible bond. CoCos are hybrid bonds that are converted to equity when triggers are breached. They were designed to provide banks with cheap capital cushions in times of stress; typically when their tier 1 assets fell below 5% of the capital structure. However, in the case of Deutsche Bank, fears that the conversion triggers may be breached have wreaked havoc on the bank's debt and equity alike. Since the beginning of 2016, the cost of insuring its non-investment grade debt via 5 year CDS protection has more than doubled.
The turmoil in the high yield market has been well documented. However, it has been thought that the damage was contained to energy related debt. If another sector of the global debt market becomes at-risk, there is a possibility of a contagion effect.
One of the many lessons to come out of the financial crisis was the relationship between liquidity and equity risk. When equity markets come under stress, the access to and cost of leverage become more onerous. You can call this the 'liquidity of leverage.'
If there is a contagion event stemming from the high yield debt market, corporations that fueled equity prices via leveraged bay backs during the last 5 years would be facing escalating capital costs. This would change the nature of the recent selloff from a market event to an economic event... that would not be good.
For now, however, markets remain resilient. The S&P has been unvanquished in its bid to hold on to its long-term support level. Time will soon tell if this is an inflection point or a mere precursor.
'The Unvanquished', William Faulkner
The S&P has tested its long-term support level twice in the past two days and both times the floor has held. The benchmark index is showing some fight at this level but as a new set of market factors emerge, the question becomes whether they will lead to a recovery rally or be the proverbial straw that breaks the market's back.
DROPPING DOLLARS, COCO BONDS AND THE MANIFESTATION OF EQUITY RISK
I recently wrote a post titled 'The Death of the Dollar Rally and Why It Matters':
http://tancockstradingblog.blogspot.com/2016/02/the-death-of-dollar-rally-and-why-it.html
The premise of the blog is that a combination of market weakness and slowing global growth are changing expectations for future domestic interest rate policy and adversely affecting the long-mighty U.S. Dollar. In spite of a healthy jobs report last Friday, the dollar's downtrend appears to be picking up steam:
As a result, stocks' of import reliant companies have gotten badly bruised while natural resources (namely metals and mining) are coming to life. A weak dollar is typically bullish for equity markets but - for the time being - buyers are choosing to stay on the sidelines instead of seeking out value.
Perhaps more troubling to the market is the rising possibility of a major credit event, the likes of which has not been seen since 2008. Deutsche Bank is actively fending off speculation that it won't be able to meet its coupon obligations on a series of subordinated debt called CoCo bonds. 'CoCo' is short for Conditional Convertible bond. CoCos are hybrid bonds that are converted to equity when triggers are breached. They were designed to provide banks with cheap capital cushions in times of stress; typically when their tier 1 assets fell below 5% of the capital structure. However, in the case of Deutsche Bank, fears that the conversion triggers may be breached have wreaked havoc on the bank's debt and equity alike. Since the beginning of 2016, the cost of insuring its non-investment grade debt via 5 year CDS protection has more than doubled.
The turmoil in the high yield market has been well documented. However, it has been thought that the damage was contained to energy related debt. If another sector of the global debt market becomes at-risk, there is a possibility of a contagion effect.
One of the many lessons to come out of the financial crisis was the relationship between liquidity and equity risk. When equity markets come under stress, the access to and cost of leverage become more onerous. You can call this the 'liquidity of leverage.'
If there is a contagion event stemming from the high yield debt market, corporations that fueled equity prices via leveraged bay backs during the last 5 years would be facing escalating capital costs. This would change the nature of the recent selloff from a market event to an economic event... that would not be good.
For now, however, markets remain resilient. The S&P has been unvanquished in its bid to hold on to its long-term support level. Time will soon tell if this is an inflection point or a mere precursor.
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