FLASH UPDATE: Friday's Cover of the Financial Times Calls For End of Junk Bond Bull Run

"Investors call time on junk bond bull run - Returns fall as easy money era nears end" - Financial Times, July 25, 2014

"Blowing Bubbles at the Federal Reserve" - American Enterprise Institute Ideas, July 1, 2014

"Could the Junk Bond Bubble Be About to Burst" - Bloomberg, June 17, 2014

"Reasons to Fear and Love Junk Bonds" - Forbes, May 8, 2014

"How to Spot a Market Bubble - Investors can get burned when the air rushes out of a hot market" - Wall Street Journal, April 18, 2014

"Junk Bond Returns Can Plunge Before Default Rates Rise" - Barron's, March 11, 2014

If you type in "high yield bubble 2014" into Google, there are 2,140,000 results.  "Junk bond bubble 2014" yields 174,000 results.  "Credit bubble 2014" shows an unwieldy 33,200,000 results.  Don't worry, there will be plenty more headlines to come.  In fact, we have considered that the headlines may be coming sooner than we expected.  

The calls from well-known investors and economists are becoming louder by the day, yet naysayers continue to try to squeeze out the last few basis points of returns from high yield bonds.  As the end of QE is now in sight, questions are starting to pop up more often as to how the exit will be handled.  Interest rates will rise soon, for reasons not yet perfectly clear to me.  One reason that I'm fairly confident in that they will not rise for is that "the economy is firing on all cylinders".  

The equity market, although not excessively overpriced, is long overdue for a correction.  Consider this data since 1929, provided by Ned Davis Research:  Average secular bull markets have 84 trading days between 5% corrections, average secular bear markets have 31 trading days between 5% corrections and the current run has had 113 trading days between 5% corrections.  More significantly, average secular bull markets have 331 trading days between 10% corrections, average secular bear markets have 91 trading days between 10% corrections and the current run has had 699 trading days between 10% corrections.  Lastly, and perhaps most alarming, average secular bull markets have 1105 trading days between 20% corrections, average secular bear markets have 486 trading days between 20% corrections and the current run has had 1348 trading days (nearly 5.5 years) between 20% corrections.

We are neither alarmists, nor permabears.  We know that there are certain well-respected economists that call for the world to regularly end, and when there is a significant bubble that burst, they come out of hiding.  This is not us...We were long high yield credit from 2004-2006, we were short high yield credit from 2007-2008, we were long again from 2009-2011 and we were then long post-reorg equity from 2011-2013.  We have been through the cycle, and feel that the time is right again.  Spreads have widened 44 basis points this month and high yield is on pace for its worst month in a year.  According to Fed Chairwoman Janet Yellen, valuations for high yield bonds "appear stretched".  Additionally, mutual fund flows are starting to turn negative ($1.68 B of high yield outflows for the week ended 7/18, including $1.07 B from HY ETFs), GDP growth is still paltry, QE is ending and interest rates will soon rise. 

Whether it is the end of QE, an equity market correction (large or small), war in the Gaza Strip, civilian planes being shot out of the sky or just the realization that risk in the high yield market is not being priced correctly, something will trigger the move in high yield that we have been preparing for.  Forget about the last few basis points of return, and consider taking advantage of the most obvious trade over the next few years - short high yield bonds.  We think the time is now. 

Please mark your calendars for September 17^th at 11:30AM EST for our next webinar with Dr. Ed Altman on the State of the HY Market.  Please reach out to Jeff Trongone for further details, or to set up a meeting to discuss the opportunity set.

Richard Travia

Director of Research

FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 22 July 2014

Comment:

The 10/5 Treasury spread bull flattened 5bps this week on geopolitical risk pertaining to Malaysian Airlines’ flight MH17 crashing near the Ukraine/Russian boarder last Thursday. The passenger flight’s crash amplified the already strained political relations in the area, inspiring a risk-off market mentality. Mortgages opened ~2 ticks wider and ended ~4 ½ ticks wider on the day. Adding to the widening, rolls came off 1/8^th tick and initial jobless claims came in stronger than expected (302k vs 310k). Overall, last Thursday was active on all fronts.

For the time being, Fed purchases continue to support MBS, as 30yr mortgages outperformed their 5yr hedge this week. FNMA 3.5s ended 8 ticks tighter, while FNMA 4s ended 5 ticks tighter. Mortgages did not fare as well against their 10yr hedge due to this week’s bull flattening. Despite the strong weekly performance, we continue to remain neutral on the basis based on balanced flows and our expectation of technicals to worsen over the next few months.

Origination ticked up $759 MM in 30yr mortgages while the refi index increased 53 points and the purchase index fell 13. While geopolitical risk (Russia, Portugal, etc.) has been driving rates lower, we find it unlikely for refinance activity to increase meaningfully. That said, we anticipate turnover ticking up as out of the money collateral continues to season.

Noteworthy:

The GNMA 4 roll was very active this week: Bloomberg prices reached a peak of 9 ¼ on July 18^th before collapsing to 8 ¼. A lack of liquidity in GNMA collateral may be a contributing factor to roll price volatility.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: High Yield Fundholders Have No Reason to Fear Janet Yellen - I wouldn't be so sure!

As I sit in my living room late on a Sunday night, with the kids and the wife asleep and the dog by my side, I start to think about all the things that keep me up at night.  Those that know me well, know that the late hours are among my most productive.   In the spirit of having a productive Sunday night, I just opened up an article written by thestreet.com titled "High Yield Fundholders Have No Reason to Fear Janet Yellen".  

Since I am always interested in hearing arguments against our event-driven, short-biased high yield thesis, and I'm constantly trying to understand the other side of the trade, I dug into the brief "details" of the article… -- High yield is not in bubble territory because defaults are low and spreads to Treasuries are not at all-time tights.  Oh, and high yield issuance quality has remained strong because the majority has been used by companies for refinancing purposes.  Lastly, Janet Yellen will only raise rates if the economy gets stronger.  -- Well, with that said, I should sleep like a baby tonight.  I am glad it is that easy...but for just a few minutes let me think more deeply about these points.  

I would argue that low defaults are actually a leading indicator of trouble to come in the high yield market.  In 2007 and 2008, the HY default rate was below 2% every month, with the exception of December 2008.  By March 2009, the "recovery" had begun in equity markets, the liquidity spigots were open and the money had begun to flow again.  2007 and 2008 was among the most severe credit crises and recessions ever, many market participants were taken out and very few survivors, if they choose to remember correctly, would likely tell you that high yield is not in bubble territory because defaults are low.  

Where the 10Y Treasury trades (yielding 2.48% - very close to Spain's 2.59%), gives no indication of risk in the market.  It is manipulated and may be prone to rise, or to stay low, for many different reasons.  If Yellen decides one day that the economy is strong enough to bear a rise in rates, I think there will be unintended consequences that will eventually come to the fore.  Once rates rise, it will be extraordinarily important to understand why they are rising, which could have a serious impact on high yield bonds.  The fact that HY bond spreads to the 10Y are not at all-time tights doesn't lead me to believe that there is nothing to fear.  Every sustained period of CCC bonds' OAS below 10% since 1997 has resulted in significant spikes in OAS above 20%.  

Two Harvard Business School professors, Greenwood and Hanson, recently published a research piece arguing that a good indicator of an overheating credit market is a high share of corporate debt issued from low-rated issuers.  High yield bond issuance has been at all-time historic levels of issuance five years in a row.  In 2011, 2012 and 2013, we saw levels of COV-Lite issuance reach all-time levels not seen since 2007 and in particular, single-B rated bonds with weak covenants were issued at multiples higher than before the last crisis.  As we know, and our advisor Dr. Ed Altman has reinforced, nearly 50% of CCC-rated issuers default inside of 5 years after issuance.  We question the quality of the junk being issued. 

Companies that have used new debt issuance over the last six years to refinance old debt, have done so at the cost of not reinvesting in their businesses.  Top lines have declined, EBITDAs have fallen precipitously, free cash flow is nil, leverage has spiked and vulnerability is high.  After second thought, I may not sleep like a baby tonight, but I do know that our investors are protected in case high yield fundholders do have something to fear.  

Please reach out to Tradex if you'd like to further discuss the short high yield opportunity and click here  http://m.youtube.com/watch?v=HKOjf1_4Bus for a link to an animated short movie on the state of the HY market.

Richard Travia

Director of Research

FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 15 July 2014

Comment:

Week-over-week, hedged mortgage performance was flat.  Although origination in FN 30s was lower by ~ $2.0 bln, the basis was unchanged at 154 bps over the 5yr yield.  Our regression model estimates that the basis is wide by approximately 2bps, but we remain cautious for now given roll weakness and Fed tapering.

Last Thursday, headline risk relating to Portugal’s Banco Espirito Santo debt drove the 10yr yield down 5 bps early in the trading day.  Fear of contagion monopolized headlines as a strong initial jobless claim print (304k vs 315k expectation) had little impact on Treasury yields.  10yr yields have since been range bound between roughly 2.50 and 2.55 for the remainder of the week.  Range-bound yields have helped the refi index remain relatively stable, as evidenced by the refi index.  Similarly, the purchase index is lower, which is expected as summer seasonals cool.

The week has extended a period of low volatility, with an implied value on the 1m x 10yr swaption remaining at 59 bps.  Furthermore, the basis neither widened nor tightened prior to Yellen’s testimony to Congress on the state of the economy.  Many raised concerns that Yellen would convey a hawkish message given recent signs of continued economic recovery.  These concerns subsided, as Yellen’s message to Congress was congruent with previous Fed communications.  Yellen expressed concerns regarding risk-taking in corporate credit.  If spreads on high-yield issuers begins to widen, other spread products (such as mortgages) may widen as well.  We await technical factors or economic/geopolitical headlines to provide short-term trading opportunities.

We continue to remain neutral on the basis.  Low volatility has stripped away short-term trading opportunities, so we continue to monitor the G2 3.5 and DW 3 flys and are constructive on their performance.  Out outlook on the G2 3.5 is especially constructive, given the price is currently -2.2/32nds!

Noteworthy:
According to an article in the NY Times[1], many hedge fund managers agree that the Fed is behind the market regarding the strength of the economy.  These investors take a more hawkish stance than the fed, and opine the need to hike rates sooner than currently anticipated.  One manager pointed out that the current unemployment rate (6.1%) is below the threshold at which the Fed has historically acted. 

The disconnection between the Fed and the market creates the risk that market may be caught off guard if the Fed hikes rates sooner than expected.  Likewise, premature anticipation of a hiking schedule could be equally costly if bonds continue to rally.  Either way, it will be interesting to see how the Fed’s unprecedented stimulus will ultimately unwind.

  

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

---

[1] http://dealbook.nytimes.com/2014/07/16/some-top-money-managers-push-for-fed-to-start-raising-interest-rates/

Jeff Kong Joins Tradex Global Advisors to Lead Mortgage Efforts

GREENWICH, Conn., July 14, 2014 /PRNewswire/ -- Tradex Global Advisors LLC, an alternative asset management company, announced today that Jeff Kong will join the firm as a partner and portfolio manager. Kong will be responsible for all mortgage-related strategies at the firm. Mr. Kong is a well-known and respected portfolio manager in the mortgage arena who has generated significant returns for investors over his 12 years of trading.

"We are thrilled that Jeff has decided to partner with us. We've known and invested with him for a decade with stellar results. Jeff's reputation as a skilled mortgage trader and his integrity in the business, combined with his track record will be attractive to investors. In the most extreme stress years he was able to mitigate losses through skillful risk management and then take advantage of the opportunity that followed," said Michael Beattie, one of the firm's founding partners and its Chief Investment Officer. Mr. Beattie further stated, "Looking forward, we certainly expect the fixed income investing landscape to change dramatically as central banks alter course and the rules change. Success in this arena requires a talented and seasoned portfolio manager as well as an equally skilled organization. I believe that with Jeff at the helm, our business has both."

"My partners at Tradex truly understand all aspects of mortgage investing. The firm has a long history in the mortgage market and has evaluated and invested successfully in many mortgage managers. It was thus a natural fit that Tradex and I join forces. We believe we have a platform that will enable us to extract alpha and provide excess returns for our investors. Our goal is twofold: to earn an excellent ongoing return stream, and as important, to be ready to capitalize on market dislocations that frequently present themselves during times of change or stress, as I've seen many times during my career. I believe our experience across numerous market cycles gives us an advantage," stated Mr. Kong.

Prior to joining Tradex, Mr. Kong was a portfolio manager at Passport Capital for the M1 Fund. Mr. Kong joined Passport from Structured Portfolio Management, where, from 2000 to 2010, he managed the approximately $1B flagship SPM mortgage fund, Structured Servicing Holdings (SSH), which annualized at +23.6% during his tenure as portfolio manager. SSH ranked as the #1 Large Hedge Fund by Bloomberg Markets in 2010 and ranked #8 in Barron's 2009 Top 100 Hedge Fund List. Previously, Mr. Kong served as a director at Donaldson, Lufkin & Jenrette for whom he was a market-maker in mortgage-backed securities. Before DLJ, he was a vice president at Greenwich Capital Markets, first, in mortgage-backed securities modeling and structuring, and later trading MBS derivatives and CMOs. Mr. Kong graduated from the University of Florida with a Bachelor's degree in Finance and Management.

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 Michael Beattie, Richard Travia and Jeff Kong. 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

FLASH UPDATE: The High Yield Danger Zone

Take a look at the animated video that @Tradex_Global made describing the tenuous nature of the HY market in 2014!  Click on the link below and enjoy the rest of the weekend.

The High Yield Danger Zone

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 8 July 2014

Comment:

Week-over-week, mortgages outperformed the 5yr, with discount MBS outpacing premiums. Spread duration partially accounts for the outperformance while the Treasury curve flattening 5 bps between 10s and 5s. 10yr Treasuries rallied 7 bps this week, causing the current coupon mortgage (FN 3.5s) to underperform its hedge by 8 ticks. Our regression model suggests that fair value of the mortgage basis (FN 30 CC yield – 5yr Tsy yield) is 153 bps or 2 bps tighter than current levels. Despite projected fair value, we continue to remain neutral on the basis and await short-term trading opportunities post Fed Minutes and initial jobless claims this week. Our neutral view is predicated on spreads being close to tights over the month, the Fed continuing its taper program and heavier origination.

June speeds on Class A securities came out faster than projected (+12% vs estimated +5-10% MoM). Production coupon FN 3.5 TBA speeds increased 15% this month despite a flat day count. The faster speeds can be attributed to increased MBS seasoning, newer issue speed ramping, and better home sale activity. The MBA Refi and Purchase indices increased 5.6% and 0.9%, respectively, from April to May.  These data points support the higher June prepayment prints. Our view is that the June and July prints may be the peak for 2014 owing to seasonal summer purchases.

Noteworthy:

Higher speeds and heavy selling by money managers over the last few days have put pressure on the roll. The FN 5 roll has fallen 2+ ticks while the FN 3.5 roll has fallen 1 tick.

Additionally, the G2 3.5 and DW 3 Flys continue to cheapen and may provide potential upside given price/carry profile.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global