Heard on the grapevine

"In advance of CDS moving to a clearing house environment, ISDA and market makers have been discussing changes to the way CDS trades. One big change is the dropping of restructuring (Modified restructuring) as a credit event in US single name CDS. The reason for this is that the settlement of that credit event is complicated in respect of deliverables and would be difficult to conduct a cash settlement auction for, which is essential for the move to a clearing house. Dealers are strongly supportive of the move, while loan hedgers (who stand to lose some capital relief as some loss scenarios would not be covered by their hedge) would like to keep the restructuring provision. No changes are planned for European CDS, which will still trade with restructuring (Modified Modified restructuring)."

I had an email conversation with someone a few months back where I said that I couldn't see this happening

http://www.reuters.com/article/bondsNews/idUSN2049973920081120

Good for my fantasy portfolio

http://www.noelwatson.com/blog/PermaLink,guid,0c5c8ee2-cafe-4a5f-9f55-e0a0af90dc9e.aspx

not so good for the UK as a whole.

Discussed here

and here

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

I didn't get round to shorting them in my fantasy portfolio as I was originally filtering for BBB names

http://www.noelwatson.com/blog/PermaLink,guid,0c5c8ee2-cafe-4a5f-9f55-e0a0af90dc9e.aspx

but this would've been one of the names in the next sweep.

Here is the 5Y CDS displayed in non-upfront format

Moody's predicted surge in defaults last week

http://www.noelwatson.com/blog/PermaLink,guid,6767fd28-27f6-4207-8989-4f61579fad6b.aspx

Happened last week

http://www.ft.com/cms/s/0/0f8c0216-b193-11dd-b97a-0000779fd18c,dwp_uuid=e8477cc4-c820-11db-b0dc-000b5df10621.html

http://www.guardian.co.uk/business/2008/nov/13/useconomy-congress-hedge-fund-managers

but only stumbled upon transcripts today

http://oversight.house.gov/story.asp?ID=2271

Soros made a fortune in 1992

Simmons runs RennTech

http://en.wikipedia.org/wiki/Renaissance_Technologies

Paulson shorted ABX indices

http://www.businessweek.com/investor/content/mar2007/pi20070308_900631.htm?chan=investing_investing+funds

Falcone is (was?) shorting Santander (they appear to have a very low CDS spread - even after recent rights issue)

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4926277.ece

Griffin's Citadel is in the news

http://www.bloomberg.com/apps/news?pid=20601087&sid=axLc1BT2ZXbA&refer=home

Thought I would cobble together a spreadsheet with all trading ideas that I have. This is a fantasy portfolio, as in real life I buy and hold forever, but I am keen to see how badly I underperform a "hold in cash" strategy. As can be seen from the second tab, I have a pool of £100m to invest, and there are numerous simplifications. I have given links on most of the ideas to blog posts where I have done some further analysis with the exception of GM and Starbucks. I have monitored GM for about three years

http://www.noelwatson.com/blog/PermaLink,guid,a5cd0517-0d1c-41e6-9bfc-f379327afb93.aspx

and think that its time may be up. Starbucks is one of the names I think will suffer with people less willing to spend on non-essential items.

Rule clarification

• Mid prices: Only if bid/ask is small. For example, when I bought protection on the UK, I was quoted 58/68 (I haggled my source down by 1bps), so I booked this at 67bps.
• Cash doesn't earn interest: Encourage to keep fully invested
• Max trade 10mm: This is a guide, but encourages not to bet all money on a few trades

I will update whenever I add/close/amend trades. One trade that I will place is to sell protection on the ITRAXX Eur when the first default occurs (either in Europe or XOver). Oil is also looking tempting to go long.

I previously mentioned that I was going to have a look at the CDS data that DTCC had recently published

http://www.noelwatson.com/blog/PermaLink,guid,5b8b455a-122a-4434-9c94-b207983b0a15.aspx

In the above link I had constrained myself to index constituents as I believed that the underlying single name trades would be more liquid and hence reflect more accurately credit risk (rather than technicals due to illiquidity). The DTCC data is here

http://www.dtcc.com/products/derivserv/data_table_i.php?id=table6

and attached is the spreadsheet I created

DTCCSinglenames.xls (163 KB)

A few things to note

1. The second tab shows the names I wasn't able to map to Markit - most likely due to apostrophes. Not a major deal
2. The third tab shows names that are no longer valid in Markit but still have notional outstanding. There may be a valid reason for this - I am joining on long name, and this is not unique. So for RENTOKIL INITIAL PLC, there are two entries in the Markit database (RENTKL and RNTKIL). However, Albertson's, Inc. should now be New Albertson's Inc
   - I'm not sure why this hasn't been changed in DTCC
   

But only by 1% from $57,894bn to $57,325bn

http://www.bis.org/publ/otc_hy0811.pdf

The Gross market Values have increased - I assume this is because spreads have widened dramatically in recent months and the number measures absolute MTM

Interesting to see that insurance firms are reducing their exposure

The notional hasn't reduced as much as ISDA's number

http://www.isda.org/press/press103108.html

a

http://www.ft.com/cms/s/0/477331c6-b0e0-11dd-8915-0000779fd18c.html

"Company default rates could rise to levels not seen since the Great Depression because of the rapid deterioration in the global economic outlook since the collapse of Lehman Brothers."

In my fantasy portfolio (posted soon), I will be selling ITRAXX Europe as soon as the first European index name (either XOver or main) goes pop.

Some Moody links here

http://www.noelwatson.com/blog/PermaLink,guid,e4d4de0b-75ea-4f20-a45e-85c8c5b86ffd.aspx

I read a couple of Tavakoli's books a few years ago

http://www.noelwatson.com/blog/PermaLink,guid,250a935d-ffc0-453d-bc2e-dd9218a4e767.aspx

and recently read the updated version of "Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization"

http://www.amazon.co.uk/Structured-Finance-Collateralized-Debt-Obligations/dp/0470288949/ref=sr_1_1?ie=UTF8&s=books&qid=1226562802&sr=8-1

which contains a whole lot of new information since the last version was published five years ago, and I highly recommend it, even for people that had the prior version.

Very useful for understanding things like

http://www.noelwatson.com/blog/PermaLink,guid,19e80fd2-0f61-4650-8afe-142458df673b.aspx

Tavakoli arguing against the bailout

http://uk.youtube.com/watch?v=nkT6FR6IJZM

which has now been reversed

http://news.yahoo.com/s/afp/20081113/bs_afp/financeeconomyworld

Commented on this the other week

http://www.noelwatson.com/blog/PermaLink,guid,4201f9f3-e07d-4a32-ab5c-90d85c4f0465.aspx

and at the end wondered how accurate the predictions would be as I feel the market is not pricing in the pain the UK is yet to suffer

http://uk.reuters.com/article/businessNews/idUKTRE4AA1X720081111

First WPP. I looked at these last week

http://www.noelwatson.com/blog/PermaLink,guid,5b8b455a-122a-4434-9c94-b207983b0a15.aspx

when looking at BBB rated entities with the highest CDS spreads. Note that I was not looking at the +/- after the BBB, as my investigation was concerned with seeing which names were likely to be downgraded to junk. WPP have been downgraded from BBB+ to BBB by S&P

At the time, WPP were trading with a 5Y mid of 287 and share price of 400.5. They are now 310 and 356. of course, this doesn't really tell us much as

• We have a small sample size
• Stock could be a high beta, and FTSE is down 10% over last week
• Noise

However, it will be worth monitoring to see if it gets downgraded again.

DSGI have been cut by Fitch to BB- from BB+. They were part of a high yield portfolio I looked at recently

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

CDS is now 850 compared to 750 in the above link

The TFS numbers were released yesterday, and were pretty gloomy

http://www.tfspropertyderivatives.com/pdf/RISK&MANAGE/2008/Nov-08.pdf

The market is saying that house prices will be at £134,346 compared with £168,158 today, a fall of 20%. This may seem excessive, as the market only fell 15% in the last year, but when you look at the -3% NSA figure for October 2008, it becomes more believable. Furthermore, if the link between mortgage approvals and house prices holds true, falls of 20% next year seem optimistic

http://www.houseprices.uk.net/articles/house_price_predictor/

As the TFS article states

"Some residential derivative market spectators are increasingly
suggesting that the house price will not fall to £134,346 in a year or to
£117,011 in three years. They could be right. Here is the thing; if you
think the levels are too low, put your buying trousers on and come to
market. Unlike every other house price forecast, the derivative
“estimates” are tradable"

The market is predicted to hit the bottom in 2011, a fall of over 40% from peak

Spreadfair aren't nearly so bearish,

but I don't think it is possible to take advantage of the apparent mismatch because

• You have to post margin
• I believe TFS is for institutional investors only
• Notionals may be a magnitude different between the two
• Slight date mismatch (and Spreadfair use Halifax quarterly numbers)

my prediction was for between 45-55% from peak, so I am still pessimistic

http://www.noelwatson.com/blog/PermaLink,guid,31834980-ddd9-4df0-a2af-60d1ebfac038.aspx

The RICS report came out this morning

http://www.rics.org/NR/rdonlyres/ED3C83E0-6B1C-4BAB-BEC2-317A5379EDAD/0/hms_1008.pdf

with NSA price balance being the worst ever, again (http://www.noelwatson.com/blog/PermaLink,guid,e6ea914a-fc1f-4d40-80d9-99654d973a29.aspx)

So, with the depressing news out of the way, let's get onto some fantasy

First, from the RICS report

"and a general feeling that the worst of the price fall may be over"

Not sure what he is smoking, but if you consider that there are a lot more job losses to come (especially in the City - this EA is based in Chelsea), the recession is yet to make itself felt fully, and those that still have a job are unlikely to have a large bonus, I fail to see why prices won't keep falling. Look at the new car sales

http://news.bbc.co.uk/1/hi/business/7712376.stm

On to the Nationwide

http://www.ft.com/cms/s/0/1a67ae82-af91-11dd-a4bf-000077b07658.html

"Nationwide maintained a gloomy outlook on the housing market yesterday, saying prices will fall by a total of 25 per cent and there might be no bounce back until 2010."

So we have only another 10% to go? Why people listen to vested interests is beyond me.

I talked about outperforming fund managers over two years ago

http://www.noelwatson.com/blog/PermaLink,guid,2060fb25-5d11-4a30-93b1-9c257651b104.aspx

Those that dispute the Efficient markets Theorem (EMH)

http://en.wikipedia.org/wiki/Efficient_market_hypothesis

argue that the fact that there are fund managers that have outperformed the index for several years indicate that the theory must be false. One example of these small band of investors was Bill Miller

but his fund suffered in the first half of 2008. Buffett is another of the market outperformers

but even Berkshire Hathaway report losses (partly due to derivatives - Buffett intends to hold these positions to maturity so will show a loss only because he is MTM rather than realised loss). Buffett recently announced that he is buying U.S. shares,

http://www.guardian.co.uk/business/2008/oct/17/warren-buffett-shares-markets

but could it be that we are suffering a market downturn not seen since the Great Depression, and markets have a lot further to go.

Someone that believes in EMH will go for a cheap (and accurate) index tracker rather than employing a fund manager to add value

http://www.investopedia.com/articles/mutualfund/03/070203.asp

The same may also be true for commodity future funds

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1279594

I've talked about CDS spread and ratings - I thought I would have a look at the index constituents. I am going to look at the names within the on the run series of the following ITRAXX indices

http://markit.com/information/products/category/indices/itraxx/documentation/content2Paragraphs/00/document/Markit%20iTraxx%20Europe%20Series%2010%20-%20Final.pdf

http://www.indexco.com/download/Products/CDS/Markit_iTraxx_Europe_Presentation.pdf

1. Europe (125 names, 52,515,829,460 net notional)
2. XOver (50, 6,041,035,647)

Notionals can be found here

http://www.dtcc.com/products/derivserv/data_table_i.php?id=table7

(more of that in another post)

Of these 175 names, I will take those that have an S&P rating on the underlying ref ob. This leaves us with 150 names. I am getting the spreads from Markit, and use EUR/MM spread.

Looking at the BBB there are 52 in Main and 3 in XOver. Some investors are only allowed to hold IG names, so if we order by CDS spread (I will filter on companies that trade on UK exchanges), and take the top 5 order by spread descending, we get

I chose index constituents as these tend to be liquid. However, with the DTCC releasing notional numbers it may be possible to include more names (if we assume outstanding notional and liquidity are reasonably correlated). it may also be worth looking at U.S. names

IndexConstituentRatings.xls (32 KB)

EDIT: FTSE 100 closed at 4639 on 4/10/2008

The pound has been whacked against the dollar recently

as people realised that while the U.S is suffering, the U.K. isn't far behind. In fact the EU say that the UK will suffer more than any mature EU economy.

http://www.guardian.co.uk/business/2008/nov/03/recession-economicgrowth

This will come as a surprise to those that believed Gordon's claim that Britain was better prepared than most to deal with the global downturn that started in the U.S. (never forget to omit global and U.S!)

http://www.guardian.co.uk/politics/2008/jan/06/uk.economy

FX analysts are predicting that GBPUSD will creep upwards over the next few years

but will their predictions be as bad as the equity analysts, and have they fully priced in the upcoming UK downturn?

http://www.noelwatson.com/blog/PermaLink,guid,6ff32223-b54c-4ac6-b1e3-6baf7d232c07.aspx

I posted his graph here

http://www.noelwatson.com/blog/PermaLink,guid,bc024a3b-6d2a-4ea1-bd0e-052811080655.aspx

but he emphasises the point here (4:15)

http://finance.yahoo.com/tech-ticker/article/53094/U.S.-House-Price-Decline-Could-Be-Worse-than-Great-Depression

house prices, adjusted for inflation, went nowhere bwtween 1890-1990.

For the U.K. housing market, one could argue that it is different over here, because we have limited space (I don't buy this). If you look at my entry last month

the trend in 2000 was 1.5% above RPI. One could ask the question - why shouldn't the trend be RPI with no adjustment upwards?

BT was one of the constituents in the HY portfolio discussed a few days ago

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

On Friday it issued a profits warning, so I thought I would see if it would trigger any reasons for selling

Reasons to sell

• Entity gets downgraded below BBB (probably too late to save majority of the fall in share price)
• CDS spread is greater than 2.5 times ITRAXX, or spreads goes above 500bps.
• Entity gets included in XOver on index roll

S&P placed BT on negative watch on Friday, but it is still BBB. The CDS spread was around 190 in early morning trading compared to the ITRAXX at around 150. So it hasn't given us a reason to see. However, I think a profits warning may well be reason to sell (if I didn't operate a hold forever portfolio), so I will be adding that to my reason to sell list. BT closed at 115 on Friday compared to FTSE at 4377. Will revisit to see whether selling would've been a good idea.