Mammas Don't Let Your Babies Grow Up to Be Treasury Traders

What can you say about Treasuries right now? I don't think they are a great risk-off hedge here. Yields are low and the Fed wants to resist negative rates. But I'm not sure they can spike much higher as the Fed is likely to buy more long-dated bonds and could move to yield curve control very rapidly if they felt the need. 5-Year Treasury Yields Moved 25% in July! Yields and credit spreads should never be quoted in percentage changes. The 5-year Treasury has been stuck in a 10-basis point band since the middle of June. The 10-year Treasury has traded in a marginally wider band, but only marginally. Treasury Volatility Hits Lowest on Record! The MOVE index, a measure of implied volatility in the Treasury market, hit the lowest level since 1990 (I didn't bother to search back longer than that). There is no volatility. Normally, as a contrarian, I'd be chomping at the bit at this level of complacency, but, given the Fed's reaction function (slow to tighten, quick to ease, a dislike of negative yields, a propensity to buy Treasuries and the potential to enact YCC), it seems about right. Credit: The Proverbial Tortoise? Credit has been OK, not great. At least in investment grade. Despite the huge supply, corporate bond spreads have marginally outperformed CDX index spreads, but that can be largely attributed to the composition of the CDX index portfolio compared to the bond index portfolio. Investment-Grade Credit Spreads: Good, but Not Great Unlike equities, or at least the Nasdaq 100, there is little conversation about credit getting back to all-time tight levels -- or even where they were in January and February. That largely makes sense, as the credit indices are more correlated with the S&P 500, not the Nasdaq. Additionally, as we will see in high yield in a moment, there is a big discrepancy between the haves and the have nots in the credit world. Finally, with Treasury yields so low, investment-grade spreads will struggle to tighten, as the all-in yield is unattractive to some buyers -- unless we get another wave of yield chasing capitulation. High yield has been a little quirkier for lack of a better word. The indices have done extremely well! The main high yield ETFs I track were up 5% last month, far better than the Russell 2000, which high yield tends to be correlated with. The funds are within 3% of their high prices in January, and with interest payments, have recouped virtually all their losses. Closed end funds are even more surprising to me. Discount to NAV has collapsed to 5% in some cases. Leveraged loan funds have not fared quite as well. The ETFs have shown some life, but nothing like on the high yield side. Similarly, while the closed end funds aren't at the depth of despair (15% discounts to NAV) they are languishing relative to their high-yield peers (10% discount to NAV on several that I track). Business Development Corporations, or BDCs, have struggled and are at least 10% lower than their June highs (using ETF as benchmark) and are still 33% lower than their February levels. The thing that I like most about credit markets is they seem to be bifurcating pricing. We are starting to see weak credits outperform and the discount to NAV on closed-end funds both are starting to strike me as frothy, but overall, credit has done a good job of pricing safe and risky credits appropriately. This recent move in high yield might finally be overdone, though. That is my gut feeling, except that it favors a reopening trade, which seems to be too readily discounted by too many as we discuss shortly. Financials - Also, Energy and Real Estate How long can markets perform without financials catching up? I'm most concerned about financials as they act as the lifeblood of the economy. The healthier and more robust the banking sector feels and trades, the better the economy should be able to do. I won't quite go out on the limb to say the same of real estate and energy, but I'd like to see those sectors gain some momentum. Maybe we get the fiscal stimulus we need out of D.C.? Maybe fears about rising Covid cases subside as they seem much better managed this time around? Maybe the Robinhood, option trading, fast money crowd, picks a new stable of companies to chase higher (like financials)? Maybe something shifts the mentality, but as much as the work-from-home trade makes sense, I am not sure that it can continue without financials (and energy and real estate) coming along for the ride. Maybe I am just too much of a boomer (don't ask my kids, because I know what they will say, and it won't be pretty)? Maybe I'm just not embracing a new reality enough? Maybe it is too simplistic to believe that competition will increase in some sectors now that the market opportunity is so apparent? Bottom Line 1. Take profits in any closed-end funds you have. 2. Take profits on investment grade, Treasuries and high yield. 3. If you have some high yield or leveraged loans to sell, you might add a bit of BDC or energy equity risk (including MLPs). 4. If you have Treasuries or IG to sell, you could look at adding financials. Credit is scary, but that is often where there is value.

Mammas Don't Let Your Babies Grow Up to Be Treasury Traders

Unlike equities, or at least the Nasdaq 100, there is little conversation about credit getting back to all-time tight levels -- or even where they were in January and February.

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