Ah the Credit Default Swap... that pesky little creature that allows you to go short on bonds, which was at the epicenter of the 2008 Great Financial Crisis, is once again at the center of attention. I speak to David Meneret, chief investment officer of Mill Hill Capital and veteran structured credit investor, about why he is buying more and more credit default swaps against high yield credit in commercial mortgage-backed securities (CMBS) and airline asset-backed securities (ABS).
In this video, Nick and I go over what credit default swaps are, why they matter, and what they indicate about systemic credit risk within our global financial system.
The full interview airs tomorrow (Friday, July 2nd.) I hope you enjoy!
Charts (courtesy of Mill Hill Capital):
High-yield credit default swap spreads are near their record lows (or "record tights" as industry vets say)
per unit of leverage, investment grade (IG) and high-yield (HY) spreads are at all-time tights...
Net leverage has soared:
and with yields so low, investors are incentivized to reach for yield in lower-rated securities...
Today @Nick Correa and I decided to explore the most important question of all in finance: how does one value a security? Sure, we all know what the price is (just look it up...) but what is the true value of something?
To answer this question, we take a look at a few clips from my recent interview with Professor Aswath Damodaran, who is the world's leading authority on the subject. Charts below. We hope you enjoy!
Formula for a Discounted Cash Flow (DCF) Model (It's the DCF, stupid...)
Equity Risk Premium over time:
Equity risk premium (red bar) PLUS the risk free rate (blue bar) = the discount rate. This is the rate at which future cash flows are discounted to the present.
Hey all, @Nick Correa are back at it again, this time breaking down how Sam Burns uses his equity risk model to determine an ideal stock/bond allocation (the riskier the market is, the more bonds and fewer stocks you would want to own).
We get into key topics such as volatility and momentum, and we also take a look at Burns' own model, the Monitor of Analysts' Earnings Revisions (MAER), and what it indicates about which sectors (financials, energy, industrials, etc.) are the most attractive at this time.
Please enjoy! And comment if you have any questions or want clarification about Sam's process. Charts below
Dividing the MSCI "All Country World Index" (stocks) by 10 year Treasury index (bonds) can indicate investors' appetite for risk (https://www.msci.com/acwi):
When high volatility stocks are doing well, that too is a sign that investors are putting their foot on the gas pedal:
Same when high beta stocks are outperforming the low volatility equities:
Interestingly, financials and energy now comprise a large part of the high beta index:
Here is Sam Burns' MAER rankings about which sectors have the best analyst earnings revisions (top to bottom):
Analyst are tripping over each other to update their earnings estimates for financials:
In our most ambitious breakdown yet, Nick "Man Of All Seasons" Correa and I venture deep into the heart of ESG investing (Environmental, social and corporate governance).
We explore the thinking of natural resource investor Marin Katusa, who argues that ESG will lower the cost of capital for firms that comply with environmental standards - and raise them for firms that dare to defy this inexorable trend.
Please enjoy and see charts below.
NextEra Energy (green line) able to secure cheaper financing (e.g. "lower cost of capital") than Marathon Oil Corp (blue line).
Performance of oil ETFs $XLE and $IXC over the past decade. Yuck
Outfperformance of Tesla and green utility stocks:
Implosion of some of the green SPACs ($NKLA and $XL)
Carson Block and @Max Wiethe taking XL Fleet to task on Zer0esTV's: "The Chopping Block":
The market for interest rate derivatives is a HUGE market (~$500 trillion notional exposure) that is incredibly important, yet it remains unknown to all but a smattering of industry insiders. I was lucky enough to speak with one such insider - Nancy Davis, a veteran derivatives trader and the founder of the The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) $IVOL ETF, the first exchange traded fund to hold interest rate derivatives (link to original interview: https://www.realvision.com/shows/the-interview/videos/are-interest-rate-traders-calling-the-feds-bluff).
Nancy plays "above the rim" and gave me a tour into her wild wild of yield curves, forward swap curves, and interest rate swaptions (the option to enter into a swap). She argued that the rates market was "calling bullshit" on the Federal Reserve and was pricing in rate hikes contrary to the assurances of Fed Chair Powell. The future path of rates is obviously the most important question right now, on everyone's minds so @Nick Correa I decided to take a deeper dive into Nancy's analysis.
I can't promise you will be a "swaption cognescenti" like Nancy by watching this video - I certainly am not. But it is our hope that you get closer to understanding the path of a colossal yet esoteric market that impacts every asset class under the sun.
Please see below for in-depth charts, and please comment any questions you may have.
There is a "futures curve" for interest rates, just as there is for oil, the VIX, the S&P 500, etc. Here is the Futures Curve for Federal Funds Rate (the rate at which banks lend to each other, controlled by the Federal Reserve):
As you can see, rate traders have been pricing in rate hikes since the beginning of this year, at a pretty steady clip.
Nancy takes it to another level, and looks at the FORWARD Swaps Curve. This is what market thinks the swap curve will look like in 3 years:
As you can see, the 3 year forward swap curve is flatter and higher than the spot curve. What matters is a) the market is pricing in higher rates across the board (not terribly surprising) but b) perhaps more importantly, the market predicts the curve will be FLATTER. This is key since so much of the rates market is based on relative trades that seek to capture the widening or narrowing of spread between different part of the curve.
As you can see, the 10 year 2 year spread is expected to decline:
Nancy thinks that this might be wishful thinking, and sees potential opportunity in going the other way - thinking that this spread is going to WIDEN - or, at least, narrow less than the market is currently pricing in.
Other charts
Commodity inflation (exerting pressure on the Fed?):
A lot of Nancy's ETF holds Treasury-Inflation Protected Securities (TIPS):
A big thank you to @Nick Correa for editing these videos to perfection, and of course to @Farrell Murphy for making sure the Exchange trains run on time.
Hello fellow hive members 🐝, @Nick Correa and I are back at it again, probably with the best edition of "The Breakdown" we've ever done. We explore the treasure trove that is @Jason Buck's interview with Meb Faber of Cambria Investments, and define what "tail risk" is, its uses, and how various assets such as bonds, gold, real estate, and foreign stocks perform during immense drawdowns of the S&P 500. We explore Meb's Tail Risk ETF ($TAIL) and break down how its various holdings help achieve its mandate of negative correlation with the S&P 500 with not too much "bleed" during normal times.
We had fun with this one and hope you do too! (charts below)
