FLASH UPDATE: Tradex's Memory is Not Short - Caution Recommended in Auto Suppliers' Corporate Credit

Tradex's Memory is Not Short

Caution Recommended in Auto Suppliers' Corporate Credit

“Subprime auto lenders will likely ease underwriting standards further in 2014 as low interest rates keep profit margins fat enough to offset rising defaults,” said Moody’s Investor Services in a recent report.  Subprime auto loan originations have increased to their highest level since the financial crisis, but as auto sales slow, lenders may cut standards to grab additional market share.  Average credit scores have fallen for three years, while average length of loans have increased.  One of the year’s most highly anticipated IPOs was Santander Consumer USA Holdings Inc., a Dallas-based auto lender, currently valued at $8 Billion.  Fed officials have supposedly recently been focused on “lurking” financial bubbles.  Well, subprime auto loans are not the only asset-class that can rapidly decline, as we know. 

I’ve read five articles over the last month about the “hot” subprime auto lending market, and I’m sure dozens more articles have been written.  The language and tone in the articles remind me of times not so long ago, when borrowing was easy and lending standards were lax.  Low interest rates, persistently high fuel costs, easing underwriting standards, direct government intervention and incentive programs have buoyed the current US auto recovery.  If history is any guide, this easy borrowing environment won’t last and it will not be without consequence.  We expect that the auto suppliers may be indirectly adversely effected by a potential auto-loan burst and directly adversely effected from an already expected cooling of auto sales.  In 2009 there were 27 auto supplier bankruptcies – caution is recommended. 

The notoriously cyclical auto industry is in its 5^th year of near uninterrupted recovery, but momentum is starting to slow.  On February 1^st, the auto industry had an 88-day supply of unsold vehicles, the most since the depths of 2009.  The recently bankrupt Detroit specifically had a supply of more than 100 days (60 days is considered healthy).  The days of big sales increases are likely over, and prices of new cars have been falling month-over-month, which certainly will no doubt build up pressure on suppliers.  US auto sales are expected to grow 2.6% this year, down precipitously from 7.6% in 2013. 

This is a bad sign of things to come for auto suppliers, who tend to be concentrated by client/auto type and need a steady flow of orders to keep revenues healthy.  Already in Q1, three major US auto suppliers saw negative earnings impact from troubles in Europe and lower sales in North America.  These issues, not to mention significant and aggressive legal headwinds (antitrust, corruption, recall issues, etc.) may create a trend that we expect to continue and to be exacerbated by any unexpected auto industry hiccup. 

Richard Travia

Director of Research

Richard Travia featured in "Visual Guide to Hedge Funds" by Richard C. Wilson

Partner & Director of Research, Richard Travia was featured in Richard C. Wilson's "Visual Guide to Hedge Funds (Bloomberg Financial)".  

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FLASH UPDATE: Borrowing has hit all-time record levels

Borrowing has hit all-time record levels

Are investors reaching too far?  Leverage is back, in a big way...  We can observe similar surges in leverage in late 1999 / early 2000 and late 2006 / mid 2007.  The latest data puts margin debt, a leverage indicator defined as the aggregate dollar value of securities purchased on margin, at record highs (in nominal and inflation-adjusted dollars).  “You can’t use this for timing, but you can use it to be prepared for trouble,” said Ricardo Ronco, head of technical analysis at Aviate Global.  The language written to describe these two past periods is eerily similar to what is being written today. 

• ie. “The National Association of Securities Dealers (NASD) has asked members to review their lending requirements in a sign of increasing concern that rising levels of margin debt could exacerbate a stock market plunge.”
• “High margin debts show the effect of over-leveraging and mispricing of risk”.
• “Either the market rises dramatically to make those loans good or in any down move there is tremendous selling pressure”.

We are not predicting a crash by any means.  We are merely pointing out a factor that could exacerbate selling pressure once it starts.  We think corporate high yield defaults will increase year-over-year and at some point over the next 3-5 years, they may be significant.  JP Morgan recently said that the concern was overblown, but stopped short of waiving the “All-Clear” sign.  The NYSE reports a metric called net debit, which is monthly total debt levels in brokerage accounts minus cash and credit.  A large positive number indicates high borrowing.  January’s reading was approaching the record high seen in February 2000.  We are at all-time leverage levels, only bested once in February 2000!

Margin debt, which rose to an all-time high in January of $451 B, is a sign to some of overheated speculation.  What if that overheated speculation over the last few years has made outsiders feel like they missed the post-crisis bounce in equity.  We are in rare territory currently, being in a 5 year+ bull market.  Of twelve bull markets since WWII, only three have made it to a sixth year.  If they felt that way, did they just invest in some “safe” high yield mutual fund or ETF.  All-time low yields and spreads in HY might indicate that this is the case.  We urge caution in the high yield space, as we continue to find additional cracks every day.

We wish everyone a happy holiday,

Richard Travia

Director of Research

Tradex Global Advisors Is Ready to be Short High Yield Again

GREENWICH, Conn., April 7, 2014 /PRNewswire/ -- Tradex Global Advisors announced today the launch of its Short-Biased High Yield Portfolio. 

The portfolio is an actively managed short-biased credit fund that targets an asymmetric return profile.  It is expected to capitalize on the current distorted credit market conditions in high yield.  The high yield market has more than $1.5 trillion in outstanding junk bonds.  Prices are at historic highs and yields are at historic lows; in-line with the 2006 credit market peak.  The Fund will primarily be short longer-dated, unsecured/subordinated, fixed-rate cash bonds.  These bonds are typically vulnerable to default or restructuring events and many may struggle to survive in this low-growth, competitive landscape.  Longs will be used to offset some of the negative carry, and will be focused on shorter-dated, secured, floating-rate bank debt.  The structure seeks to minimize negative carry, allowing Tradex to remain patient for company-specific events to occur.

Tradex was invested in short-biased high yield strategies in 2007-2008, achieving very strong results before exiting the trades early in 2009.  Tradex believes it is the right time again in the high yield cycle to be short.  The firm's Chief Investment Officer,Michael Beattie, said, "It is impossible to perfectly time the events or defaults in highly levered, high yield companies, but I believe this is pretty close to an all-time top."  He believes that the indiscriminate buying by yield hungry investors will end badly.  Richard Travia, Tradex's Director of Research, said, "By all metrics and in our opinion – including spreads, yields, prices and quality – B & CCC-rated bonds have very little upside and tremendous downside risk."  Travia goes on to mention that, "This is not a blanket macro call on all of high yield, rather it is a company and event specific strategy."

About Tradex Global AdvisorsTradex Global Advisors, LLC (TGA) is headquartered in Greenwich, Connecticut.  TGA manages opportunistic internal hedge funds and niche-focused fund of hedge funds.  With its targeted focus, TGA seeks to identify very specific trading opportunities and to partner with highly experienced teams to execute the strategy.  TGA was founded in 2004 and is managed by Jeffrey Trongone, Michael Beattie and Richard Travia.  TGA was an affiliate and spinout of Tradex Capital Markets, a large and successful macro fund of managed accounts that launched in 1998, collectively with peak assets of more than $3 B.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

SOURCE Tradex Global Advisors, LLC

RELATED LINKS
http://www.thetradexgroup.com
http://www.prnewswire.com/news-releases/tradex-global-advisors-is-ready-to-be-short-high-yield-again-254195431.html

FLASH UPDATE: Mortgage Spread Drivers Historic and Current

Mortgage Spread Drivers Historic and Current

Has the 600 pound gorilla – the Fed – changed the rules of the game?

Broadly speaking, mortgage spreads tighten as rates rise and widen as they fall (see graph A).  This pattern exists because Agency Mortgages, with their government guarantee, offer a higher yielding alternative to Treasury securities.  As rates rise, investors tend to “reach for yield” to offset losses in other parts of their portfolios.  Stated differently, investors will increasingly prefer Agency Mortgages over Treasuries in a bearish market environment as the higher yield of mortgages will help buffer losses in a down market.

The other phenomenon that frequently impacts the mortgage basis is volatility: as volatility increases, mortgage spreads will widen and vice-versa (see graph B).  How does volatility play into mortgage valuations?  Mortgages are similar to Treasuries, except that an MBS investor is short an option.  In the case of MBS, the embedded option is the right to refinance, which is owned by the mortgagee.  The more volatile rates are, the more likely the mortgage is “in the money”, and the more valuable the option becomes.  Volatility will hence cause mortgage prices to decrease and spreads to increase.

Graph A

Graph B

How have these two truisms panned out as the Fed tapers its unprecedented asset purchase program?

When rates rose in the second half of 2013, mortgage spreads widened counterintuitively as investors preemptively priced in the Fed’s decision to taper its asset purchase program.  By year-end 2013, the rising rate/spread tightening phenomenon was restored to its traditional relationship.  Namely, as rates began to rise, spreads began to tighten.  It is clear that investors believe that Fed tapering will continue at a rate of $10 Bln per month, and will continue to completion near the end of 2014.  Going forward, as rates rise, we are constructive on the mortgage basis.

However, that is not the end of the story. The Fed still has a meaningful impact on market volatility, which will continue to impact mortgage spreads.  For example, recent Fed meeting Minutes attest to the Fed’s impact on rate volatility.  Both the March 18-19 Fed meeting Minutes released on April 9th caused significant volatility in the Treasury market.  The volatility stemmed from a change in the market’s expectations of forward guidance of an interest rate hike.  The Fed will continue to play a dominant role in driving market volatility for as long as the eye can see.

To summarize, we believe the data-driven Fed policy environment we live in today will continue to offer investment opportunities for astute investors, even long after the Fed ceases its unprecedented asset purchase program.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Mall Traffic Declines Foretell a Scary Story for Many Retailers

Mall Traffic Declines Foretell a Scary Story for Many Retailers

Sbarro is going out of business (again)!  My late-80's / early 90's teenage self just had his food court meal decision of Sbarro, Panda Express or Roli-Poli made that much easier.  Sbarro recently filed for bankruptcy for the second time in three years, specifically citing slowing customer traffic in its shopping mall locations.  

For full disclosure, aside from pictures of my kids with Santa Claus and the Easter Bunny, I don't think I've been in a mall to shop in a solid 15 years.  The crowds (obviously less so nowadays), the perfume mist shower waiting to fill your lungs as you race through some dingy department store that you needed to enter the mall through, the inefficiency of having to walk end to end to get to a store that may or may not carry what you want, for an item that most likely isn't on sale...No, I think I'll just sit in my cozy home on my tablet, or in my office on my PC, or in my car on my iPhone and just type in six easy letters.com (A_M_A_Z_O_N).  I might have been ahead of my time in my disdain for malls, but I am no longer in the minority.  

Retail analysts have been cutting earnings targets nearly across the board as mall traffic continues to precipitously decline.  The last holiday season was particularly dire as slowing traffic trends, combined with slipping consumer confidence, lack of must-have fashion items and unbearably cold weather in most (my) parts of the US resulted in 15% declines in foot traffic.  Just last week, Brookstone filed for Chapter 11.  The bankruptcy is planned and Spencer's will be acquiring some combination of its assets and liabilities.  First, let me get past the fact that Spencer's is still a company.  I guess they sold enough whoopee cushions and gag gifts to stay alive all these years...Bravo.  Second, I suppose Brookstone's business model of having brick and mortar stores in malls where road weary shoppers can pull up, sit down in a massage chair and get a free 10 minute relaxation session without any glimmer of an obligation to make a purchase doesn't work.  

Target, American Eagle, Aeropostale and Macy’s are just some of the many mall-heavy retailers that have significant plans to close stores and fire employees.  The point is that the industry is going through a multi-year period of store closings and reduced square footage.  Some estimates expect retail square footage to be cut by a third to half in the next five to ten years.  Interestingly, Rick Caruso recently said at the National Retail federation Convention that he was unaware of a mall being built since 2006.  2006!!!

Online retailers are gaining significant market share every day and online shopping is a fact of life now, worldwide.  Quicker, easier and cheaper shopping methods are available to most at the click of a mouse or a swipe of a finger.  We expect this trend to continue and for many traditional brick and mortar retailers to have a difficult time transitioning.

Richard Travia
Director of Research

FLASH UPDATE: Two weeks after Yellen / FOMC Announcements – A Look at the Impact on the Mortgage Basis

Two weeks after Yellen / FOMC Announcements – 

A Look at the Impact on the Mortgage Basis

Since the much anticipated FOMC meeting on March 19^th, Yellen’s first as Chair, the Treasury yield curve experienced a bear flattening.  The 5 Year Treasury Note led the selloff, increasing 22 bps in yield.  The selloff was not surprising given that Yellen conveyed rate increases could begin as early as six months after the Fed’s bond buying program ceases. Yellen also stated that a potential rate hike decision would be dependent on a range of economic factors, effectively giving the Fed more policy discretion.  The mortgage market largely anticipated the FOMC’s decision to cut another $10 bln per month in bond purchases.

Mortgages performed well against their Treasury hedges since the announcement (see lower panel of Graph A below) as spreads tightened. A longer term view in Graph B shows that spread tightening should be expected as rates rise.

The first half of 2013, however, was a bit of an anomaly as mortgages underperformed treasuries in a rising rate environment.  The anomaly was driven largely by mortgage investors preemptively discounting the Fed’s immanent initialization of Taper and market technical factors.

At this point, the mortgage market seems to have fully digested the Taper projections.  Recent events appear to have confirmed that the mortgage market has returned to its traditional footing as an excellent performer in a rising rate environment.

Graph A

Graph B

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Let's Keep Inflating that HY Bubble!

Let's Keep Inflating that HY Bubble!

Inflows…Tepid Growth…Yield Compression…Spread Tightening…New Issuance…Low Defaults…QE…Can-Kicking…

What do all of these things have in common?  They are all features of the current fully-heated high yield market that I hope will continue, for now.  I am crossing my fingers and toes, rubbing my lucky rabbit’s foot, holding my special four-leaf clover close to my heart, avoiding ladders, mirrors, black cats, and cracks in the sidewalk…

We think that there are significant reasons to be skeptical of the high yield market’s ability to hold up.  That being said, we want to accumulate as many ugly, highly-levered, negative free cash flow generating, falling EBITDA, bottom-dwelling, vulnerable credits as possible at prices above par and call values. 

A unique feature in the high yield market is that many bonds can be callable.  This feature gives the issuer the privilege to redeem the bond at some point (or several points) before reaching maturity, typically at a premium to par.  In more normal, less bubbly, times, these callable bonds offer a higher coupon to investors to compensate for this ‘option’.  In falling interest rate environments, companies can use this feature to ‘call-in’ previously issued debt and to refinance it at a lower interest rate.

This callable feature is key, in our opinion, to creating true mathematical asymmetry in a short high yield strategy.  Some of the most vulnerable B & CCC rated high yield bonds are trading at prices above their call-values.  This means that between now and the call date, the upside from a price perspective is likely severely limited and constrained.  Combine the notion of call-ability with today’s low absolute yields (negative cost of carry) and you have a mechanism where one can wait for certain negative catalysts or events to occur in specific securities.  So for now, let’s keep that bubble inflated. 

Richard Travia
Director of Research