CBOE / CDX HY one-month volatility (Credit Vix), via S&P

That still leaves the problem of long-term strategy versus how to actually trade the market effectively, because we are talking about big moves overall — and there has been plenty of opportunity to make gains, or take a painful hit. This is where my quote above from Emmanuel Lasker, the longest reigning world chess champion (1894-1921), comes in. 

Call it proactive patience. I still believe we are dancing around the event horizon of a global downturn, but at this stage the thesis seems not very helpful for market participants — particularly the more active traders. Rather than trying to heavily position into something that might take a long time to unfold, far better to round off 2023 on as sure a footing as possible by accumulating small advantages.

That said, almost every market is screaming correction now, hence my title reference to ‘zugzwang’, a position in chess where any move causes deterioration (and hence the obligation to move is a disadvantage). Credit is far from the only asset class that is overbought or oversold. It will take a better brain than mine to find the combination — if it exists — that unlocks how all these parts move from here. But I’ll have a stab at how I see some of them riffing off each other.

In any case, it’s a good time to re-examine and test one’s base assumptions. For me a very basic assumption was that CLO and LevFin primary would be done for the year after Thanksgiving. But the sustained rally and disappearance of volatility mean that is no longer a given. I can well imagine some deals braving these calm looking waters, even if there’s not actually that much liquidity. Aside from those already marketing there is a growing list of CLOs primed for Q1 24, so might not one or two managers look to steal a lead on the pack? Other than general readiness the main hurdle remains the arb, with lower rated tranche pricing remaining a bit stickier than the top tiers.

Source: Deutsche Bank

In the US loan market, with prices having rallied and fund outflows abated, the market testers mainly look to be borrowers trying to cut funding costs — be it Atlantic Aviation, Avis, Charter Communications, Life Time Fitness or Summit Materials. Even with cash to put to work there appears less scope for new money deals or LBO financing. In Europe the feeling is something similar, although rumours that Synlab’s well flagged buyout package might finally hit the market still circulate — arguably it’s a well known situation so shouldn’t spring many surprises.

After the year we’ve had, it would be natural for investors to protect their gains or lick their wounds. Actually, people generally say that around this time of year. Either way, you wouldn’t expect many to take directional punts or boldly allocate new money. But to use another game analogy, the market has been a skilled poker player this year, full of bluffs and unpredictable. It may yet reel in another round of bets as it slow plays the hand to the river card.

With this edition of Macro Prophet, I am fortified by Lasker’s injunction to keep things simple. There are several macroeconomic data perspectives that are worth mentioning, but let’s start with a glimpse below the headline numbers in leveraged credit markets. Even in the long line up of suspects for being overbought, credit is conspicuous.

No-one could have been in any doubt last week that credit markets felt firm — and they still feel pretty firm despite a slight widening of spreads on Monday (27 November). High yield bonds hit new cycle highs on Wednesday last week, although not keeping up with CDS — as I explored in this article here. Various CLOs stormed over the finish line ahead of Thanksgiving — and more are coming through this week.

But there’s an air of disappointment lingering around loans even though nothing bad has happened. Unlike bonds, loans had not quite — at that stage — hit the September highs and there is more dispersion in loan performance than high yield bonds, which have been on a big compression drive over recent weeks.

Morningstar European Leveraged Loan Index total return

If loans aren’t so compliant, it’s possibly because CLOs own most of them and are looking to minimise their triple-C exposure. That puts the emphasis on establishing portfolios that are double-B or single-B plus, and leaves single-B minus and triple-C loans rather out in limbo. They need to find another type of natural bidder, which so far is proving a challenge. Or, they need sponsors to inject more equity.

Speaking of equities, the S&P has surged back from what looked in October to be a dismal capitulation. It’s not quite back to the highs of the year but it’s more or less there — and, yes, looks overbought.

S&P 500

Once again it is tech stocks driving the rally. Arguably you could say the same distortions of true stock market performance are once again at work, but even the Russell 2000 small cap index is starting to look a lot more optimistic than it was.

Russell 2000

One doesn’t need much of a step back to see the underpinning macroeconomic drivers. S&P 500 earnings in Q3 generally surprised to the upside, while in their latest round of comments even the more hawkish US Federal Reserve committee members sounded like doves — noting things like the economy is well on track to meet it’s 2% inflation target, that this has been the quickest retreat of inflation in 71 years, and — oh — we might pivot. I would be worried about that velocity on a slippery slope, but to the market it sounds good as that could mean a pivot comes sooner. It would be an awful shock if the Fed decided to hike rates again.

UST yield curve — 10-year was close to 5% not that long ago

US Treasury yields are in retreat on this rhetoric, as well as the decline in global oil prices and because the country registered a higher than expected 5.6% fall in monthly new home sales for October. I believe — and have believed for some time — that big problems are fermenting in US housing, and slumping oil heralds economic contraction. But for now the market is happy to take that as further assurance the Federal Reserve is done with hiking. The even bigger dynamic in USTs, from a technical perspective, is that the dis-inversion narrative between two- and 10-year has fallen away once again. That historically would have been a strong indicator of looming recession, but at 4.3% the 10-year yield is some way back from the 5% it previously touched.

UST 10yr minus 2yr yield — source: Ycharts

The suddenly dovish Fed is at odds with the maintained hawkish tone of other central banks — and this mismatch sits even more strangely if you believe (as I do) that the US is better equipped to endure a higher-for-longer rates environment than, say, Europe. This mismatch plays into another very big part of the global macroeconomic mechanism — the plummeting US dollar.

The US dollar index, which tracks its performance against a basket of other currencies, has now retraced so far that it has given up more than 50% of its previous gains and the dollar is testing or breaking through 100-day moving averages versus other global currencies like the yen, euro and sterling. This puts it firmly in the oversold bucket, but would you place a bet on a big reversal? For that, something needs to change in central bank messaging, US treasury yield direction, and/or the price of oil. Maybe all three — and something else (I’m leaving this open).

US dollar index (DXY)

The falling dollar helps explain why precious metals — notably gold — have been on a sharp rise. In fact gold recently touched the highs of the year, previously set in May, and suggests it might be also overbought, or reaching some kind of capping point.

Gold price $/kg — via Bullion Vault

And crypto — wow, do you remember those giddy days back in 2020/21 when you bought into Algorand or somesuch to top up your ailing credit returns? Well, that is back on the rise — and very much supported in headline numbers (the thing that get crypto tourists’ attention) by their exchange rate versus the falling dollar. I’ve a little more to say about this, but let’s just look at one more strange facet of the macroeconomic backdrop.

BTC/USD price

Global Purchase Manager Index numbers are still a nightmare. They don’t look healthy at all. To diagnose the condition and offer a prognosis, I would say the global economy is going to retract, that companies are very much preparing for slower or falling earnings, and this means you should expect employment numbers to drop. Which means less consumer purchasing power and so on.

Purchase Managers Index numbers globally — source: JP Morgan Asset Management quarterly guide

Leading indicators like this don’t paint a materially different picture than they have throughout most of 2023, although I’ll point out the US PMI slipped to 46.7 at last reading (October), with a number below 50 pointing to expected contraction. But clearly these factors have not yet added up to the big downturn or the credit market defaults and dispersion that were once expected. Even banks like Deutsche Bank that had a Q4 recession as their base case appear to have modified the view — the latest being for a mild recession sometime in 2024.

I’ll be like Lasker for now and stop trying to see too far ahead, in case it breaks my brain. But short term I’d venture we have at most a week or two more of solid road for borrowers to bring deals, and then liquidity will freeze over and the mid-December central bank messaging probably leaves everyone in jitters over the Christmas break. Happy times.

Coming back to crypto, I’m starting to worry even my most nailed on — and privately guarded — thesis may have come unstuck. Two factors I’ve looked at had promised to avail one of the biggest buying opportunities since the 2020 insanity. Firstly, the total market cap of crypto assets had slumped to around the $1.3trn mark, which was less than half what it was and not too far off the $1trn bottom of crypto’s logarithmic regression bands (in all previous cycles it has dipped just below this at the worst point and then bounced back up). Secondly, there has been a gradual but convincing rotation of remaining crypto capital out of alt-coins and into Bitcoin (BTC), causing its dominance to edge up over the year.

Crypto total market cap logarithmic regression bands — source intothecryptoverse.com

As such, I saw it as a simple matter of time before crypto total cap hit the bottom of the band and BTC hit 60% dominance, at which point I’d have shouted “YOLO in now!” like some crypto idiot. Throw in your retirement fund, sit back and watch the alt-coin season make you wildly rich.

Except now the slumping dollar is already bringing other idiots back to the flame like moths. This is also evident in how game stocks are suddenly back on the rise. Suddenly, I have less idea whether the BTC dominance narrative can be sustained and am not nearly so confident what happens to crypto total market cap in the coming months. For the sake of sour grapes, let’s assume there’s another crypto crash on the way. I’m calling it — overbought!

Better luck to all of you finding your magical combination in this macro mess

Chess HODLer Emmanuel Lasker, source Wikipedia