Friday, 21 December 2012

Update - Credit / Equities & Credit / Equities Volatility in Europe

"I conceive that the great part of the miseries of mankind are brought upon them by false estimates they have made of the value of things." - Benjamin Franklin

In continuation of our July conversation relating to the relationship between  European Credit versus Equity volatility from our good cross-asset friend (who pointed at the time to the relative attractiveness of being long credit and long volatility), please find enclosed his latest remark on the relationship between Credit and Equities.

Although cross-asset correlations have been diminishing in the last couple of weeks with credit spreads moving tighter and equities markets moving higher, they nevertheless remain globally elevated and statistically significant. The strength in this cross-asset relationship requires close attention, given the on-going excessive search for yields which could have a long-term impact (relative immunisation risk of credit versus equities).

Graph: Correlation R square between Credit Index Itraxx Crossover (High Yield gauge) and Eurostoxx 50 Volatility 1 year (rolling 6 months: -  source Bloomberg:

Couple of points:
- the current levels of Investment Grade Credit / Equities / Equities Volatility are coherent, on High Yield, spreads seems to be relatively tight versus equities.
- the relationship between credit / spot equities has been through two significant diverging periods in 2012. First in early 2012 (where IG spreads and High Yield did lag the rally in equities) then in March / April (the sell-off in equities only marginally spread to credit, which offered an attractive opportunity of buying CDS / Equities).
- the relationship between credit and Equities Volatilities only went through one clear disconnect versus Investment Grade in June / July: sell CDS signal versus buying Equities volatility and two periods of clear disconnect with High Yield (end of May: selling Equities volatility / Buying Itraxx Crossover - June / July, same  opportunity for IG (see July post quoted above on that subject).

Please see below charts displaying the relationships YTD. These relationships are expressed via power regressions on the period, please note the roll impact for credit indices has been taken into account.

Investment Grade : Itraxx MAIN vs Eurostoxx 50 spot - source Bloomberg:

Investment Grade : Itraxx MAIN vs Eurostoxx 50 volatility 1 yeat ATM (At The Money) - source Bloomberg:

High Yield : Itraxx Crossover vs Eurostoxx 50 spot - source Bloomberg:

High Yield : Itraxx Crossover vs Eurostoxx 50 volatility - source Bloomberg:

Stay tuned!

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