Bank Credit Weekly: Melt-Up in Asset Prices or Melt-Down in Conviction?

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Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus

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Gravity Works As WeWork Doesn't; Now Plan B

Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

We have been here before. As the Fed places achieving full employment above its goal of stable and low inflation, risks to financial stability should rise. Stability may be threatened by asset bubbles which are already likely to be forming in asset markets.At the same time, the fear of missing out (FOMO) is pushing investors to be invested while herd mentality provides job protection for asset managers that remain invested. The risk of an equity correction grows in the background. The issue is the lack of a catalyst for now. However, when it does arrive, the question is whether it is accompanied by a flight to quality in the bond market or if rising inflation expectations keep pushing market interest rates higher. Correlations may be reset in the latter outcome and some asset managers could implode in that scenario.We have been here before, as well. Counterparty failures and concerns regarding central clearing house stability may be the hot topics by the end of the year. As such, credit analysts should re-assess their exposures to the former, the prime brokers. Concurrently, now would be an opportune time to buy protection via credit indexes or credit default swaps. Most asset managers will not, as they are protected by the herd, but fortune favors the brave.In the near term, the market is gaining a newfound appreciation for the obscure mechanisms that influence short-term interest rates. We do our best to explain these tools inside and for more background on these pressures, please see our most recent <a href="https://www.smartkarma.com/insights/bank-macro-manifest-risk-rally-gathers-steam-as-bad-news-more-stimulus" target="_blank" data-smartkarma-citation="insights:47886" rel="noopener">Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus</a>. More importantly, this concern is new and something new creates an opportunity. This is where the price of protection could be earned.Only the patina of time will tell if we are right in our correlation and counterparty concerns. But why risk it? Now is the time to think outside the box. Credit investors are not just playing for carry. Price appreciation may be gone, but credit investors need to play for highly efficient carry. Emerging Market and other High Yield assets will likely be impacted by the dislocation in short-term interest rates as investors bid-up higher yielding, short duration assets. A melt-up should occur before we get to the eventual meltdown. This is where to position.As such we identify our top 10 bank securities to position within to ride the melt-up. Downside risks are limited to potential opportunity costs from not investing further out the curve. However, we suspect that many investors are already full of long duration positions. The upside is that, if we are correct, these securities could also outperform in a meltdown. Therefore, our top melt-up picks may dovetail with attempts to reduce duration as the year proceeds.

We have been here before. As the Fed places achieving full employment above its goal of stable and low inflation, risks to financial stability should rise. Stability may be threatened by asset bubbles which are already likely to be forming in asset markets.At the same time, the fear of missing out (FOMO) is pushing investors to be invested while herd mentality provides job protection for asset managers that remain invested. The risk of an equity correction grows in the background. The issue is the lack of a catalyst for now. However, when it does arrive, the question is whether it is accompanied by a flight to quality in the bond market or if rising inflation expectations keep pushing market interest rates higher. Correlations may be reset in the latter outcome and some asset managers could implode in that scenario.We have been here before, as well. Counterparty failures and concerns regarding central clearing house stability may be the hot topics by the end of the year. As such, credit analysts should re-assess their exposures to the former, the prime brokers. Concurrently, now would be an opportune time to buy protection via credit indexes or credit default swaps. Most asset managers will not, as they are protected by the herd, but fortune favors the brave.In the near term, the market is gaining a newfound appreciation for the obscure mechanisms that influence short-term interest rates. We do our best to explain these tools inside and for more background on these pressures, please see our most recent Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus. More importantly, this concern is new and something new creates an opportunity. This is where the price of protection could be earned.Only the patina of time will tell if we are right in our correlation and counterparty concerns. But why risk it? Now is the time to think outside the box. Credit investors are not just playing for carry. Price appreciation may be gone, but credit investors need to play for highly efficient carry. Emerging Market and other High Yield assets will likely be impacted by the dislocation in short-term interest rates as investors bid-up higher yielding, short duration assets. A melt-up should occur before we get to the eventual meltdown. This is where to position.As such we identify our top 10 bank securities to position within to ride the melt-up. Downside risks are limited to potential opportunity costs from not investing further out the curve. However, we suspect that many investors are already full of long duration positions. The upside is that, if we are correct, these securities could also outperform in a meltdown. Therefore, our top melt-up picks may dovetail with attempts to reduce duration as the year proceeds. 

Grupo Financiero Banorte SAB d (GFNORTEO MF)

Bank Credit Strategy: Melt-Up Before Meltdown, Where to Position

Asia High Yield Bond Index

Bank Credit Strategy: Melt-Up Before Meltdown, Where to Position