The
relationship between stock price volatility and CDS spread is statistically
strong, with a historical correlation close to 0.70 in both regions.
Below, a
comparison of current Volatility and Credit levels
- Volatility is measured as V2X and VIX
- Credit is measured as Markit Itraxx Europe and USA Generic
5Y corporate CDS (basket of 125 cds for each)
Source: Bloomberg
And the
graphic representation of historical levels since 2004
Source: Bloomberg
Source: Bloomberg
Today, credit is in 80th percentile and 63rd percentile in Europe and USA, respectively while equity volatility is in the 52nd percentile and 34th percentile. In Europe, the spread is particularly large. This conflicting signal puzzles me, especially if I look at the following items (the list could be long):
-
Still potential breakup of the eurozone, with all the mess
it implies
-
ESM still not in
place and no clear support for a banking license that will allow the entity to
fund itself
-
ECB bond purchases seniority issue not resolved, pushing
private investors down the pecking order of creditors
-
Deterioration of corporate earnings and economic
indicators
From the
other hand, the spread between equity volatility and credit could remain at
high levels
-
The performance of equity markets is not that bad (+5.4%
so far in 2012), served by relatively better yields than in the rates market
and low valuation
-
The CDS index has 25% of financial companies against 22%
for the Equity index, explaining part of the difference
-
Also, CDS has underperformed vs Cash, due to the lack of
liquidity in the cash market and positive basis
As the
answer will come from our politics, so the catalysts to look at in September
are the following:
- 6th Sep : ECB Meeting :
SMP details?
-
12th Sep : Constitutional court of Karlsruhe for ESM vote
-
13th Sep: Fed meeting: QE3 or not QE3?
-
15th Sep : Euro Group meeting
What
history tells us:
From Luc
Laeven and Fabian Valencia, IMF : "An interesting pattern emerges: banking
crises tend to start in the second half of the year, with large September and
December effects."
From
Roggof, Harvard: crises to happen in election years. The intuition behind is
that crises are the result of imbalances that accumulate over a long time.
Politicians have a strong incentive to delay dealing with them until after an
election, and often, as was the case with Greece, to actually hide the truth
until the polls close. We had Elections in France, and US and China leadership
transition on the agenda.
Personally,
I tend to think that August will probably remain quiet.
However, I am really worried
about September 12, Equity
volatility should explode.
So let’s enjoy the end of the summer while it lasts.
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