Within OTAS we use many metrics to keep an eye on risks for equities. Credit default swap (CDS) spreads have been a coincident and occasionally leading indicator of trouble, especially for the bank sector. And when the bank sector is in trouble, the rest of the market tends to follow.
The median CDS of European banks spiked of late. A rise in value happens when debt investors become concerned that their bonds will not be honoured in full, while a fall back indicates that those concerns have eased. The latest reassurance was rapidly forthcoming.
It is worth pointing out that risk remains elevated relative to the average level over the past two years. A couple of years ago 100 bps of risk was the point at which we might start worrying about corporate credit, but in a world of zero and negative interest rates, 100 bps seems pretty high (I’d like it on my savings account please, Mr. Banker). The risk however, remains well below the peak of nearly 350 bps reached in 2011 and was put back in the box pretty quickly over the past two weeks.
Once again the ECB rode to the rescue, with another promise of saving the financial system (read the Euro and the politicians whose entire careers depend on it), with what once was quaintly referred to as unconventional monetary policy. Of course, for prices of CDS to fall as they have done in the last couple of weeks, someone has to become much less risk averse. That someone is anticipating unloading all unwanted bonds onto the ECB at sometime between now and expiry.
The consequence of a central bank buying corporate debt is that corporate debt no longer carries the same signalling quality for equity investors. It may be that we need to pay much more attention to far smaller moves in the median CDS, for it is by pushing up the price that investors signal they need another intervention from the ECB. These investors are hungry offspring, nuzzling mother, until she rolls over to uncover her teat.
There remain other measures of risk. Short interest is one that has had mixed benefits, because the authorities are prone to interfere in this market pretty rapidly. The steady rise in short interest on the average European bank year-to-date however, would appear to be sending a message.
It is noteworthy that Nordic banks are among the most shorted names listed in OTAS, with the highest days-to-cover and loan fees.
A third measure of risk is the implied volatility in the options market. This both follows the underlying move and is an indicator of by how much investors believe shares could move. Within OTAS, we measure this over the upcoming three months.
Option volatility is a measure of uncertainty about the future. You should pay a higher price for something that you are more sure about, which is why the favourite in a horse race has the lowest odds. Low implied volatility typically suggests that investors believe the good times will keep rolling.
Investors predict, using money not words, that the average bank will move in a range of over 36% by mid-June. This is either up or down by more than 18%. Follow the CDS and short interest for European banks within OTAS in order to gain a better understanding of whether investors believe that move will be up or down.
OTAS also provides in depth analysis of risks for individual equities, as well as easy to access summaries of sectors and markets, which highlight the individual companies most expected to face difficulties.