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All posts for the month August, 2016

Sustained periods of low volatility correlate well with steadily rising equity prices. Yet concern is mounting that the current low volatility is storing up future problems, because investors are doubling up on high share prices. By selling put options on shares and indices, thereby committing themselves to buy shares should the prices fall, these funds are exposed to an equity market sell-off through both their ownership of stock and the recently written put options.

It is perfectly rationale to sell puts if you believe that markets are rising. The concern however, is that funds are so starved of yield that they are writing puts for the short-term income benefit and relying on the world’s central banks to bail them out should stock markets take a dive. A parallel is drawn with the sub-prime mortgage debacle, when it was not the size of the market for poorly underwritten mortgage loans that triggered the financial crisis, but the vast number of derivatives layered on top that magnified risk throughout the financial system.

US Implied Volatility - 2 Years

Implied volatility for the top 500 US stocks has fallen sharply since the post-Brexit panic and even more significantly since the worries about global growth were at their height in February. Yet as the chart above shows, two year implied volatility remains in its average range and around 10% above the successive lows of 2015.

US Implied Volatility - Longer Term

On a longer timeframe the shock from the financial crisis and its echo in 2011 are clearly visible, but the current level of implied volatility is not unusual in the post-crisis period when central banks have been deliberately dampening volatility in order to encourage risk-taking. Implied volatility for US large caps is 6% above the low point of its average spread. In Europe the picture is similar and implied volatility is 18% above the bottom end of its normal range, which has repeatedly marked the low point for this indicator.

Europe Implied Volatility

The charts appear to support the strategy of the put sellers, because implied volatility still has room to fall to reach previous lows, during which time the options sold will expire worthless. The put writers are also doing central bankers’ bidding by taking more risk, so they will feel justified in expecting central banks to bail them out when necessary. Large, long-only funds find it difficult to react to sudden moves in markets, meaning that they miss their chance to scoop up large quantities of shares before prices rally back to where they were. A logical way to ensure that these funds benefit from temporary corrections is to write puts so that they are guaranteed stock immediately prior to a central bank induced bounce.

There is a near-term benefit in enhanced portfolio returns because of the income from writing puts, but the longer-term gains are based on the assumption that central banks will continue to do what they have been doing since 2009. Janet Yellen may lay out the path to higher interest rates in her speeches, but as long as the Fed is seen to be ready to ease monetary policy whenever markets are in stress, the put-writing investment strategy will work.

OTAS users may keep a close eye on the trends in implied volatility to see when the current normal moves become exceptional. They should also look for confirmation from other indicators presented in a similar fashion, such as the cost of credit for corporates derived from the CDS market.

 

The market often overlooks or neglects the potential signalling risk contained within company Insider Transactions. Investors are typically provided with basic trade details like who, how much and which direction but we’d argue there is simply not enough to infer positive or negative performance bias based on this information alone.

Using our prescient analysis, OTAS provides a unique star ranking which accompanies the Insider stamp telling you immediately whether the latest transaction by a company director or major shareholder has predicated the future price direction of the shares. From as little as a single well timed discretionary trade, OTAS can identify which insiders historically you should follow and those you shouldn’t….

The recent buying in retailer Metro AG is a prime example of one you should……

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3-Star rated Supervisory Board member Juergen Steinemann purchased €1m of stock on Friday. Singling out his own previous transaction history it is evident that he possesses particularly astute market timing, buying close to the trough after multiple periods of decline and prior to subsequent strong rallies in the share price.
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Of course an investment decision is not made on one factor alone. The Core Summary allows you to quickly draw conclusions on the state of a company by analysing a range of multi-asset observables to understand if and where additional risks(or opportunities) may lie.
In Metro’s case, the company is currently not displaying any undue signs of risk but conversely is supported by a continued contraction in credit spreads and short interest, whilst company sentiment remains positive with the sell-side in the TIM alpha capture platform, displaying a 9 score on the TIM indicator stamp.

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Don’t forget live Insider transactions are available via your intraday Alerts feed, so you’ll never miss a new, potentially price impacting trade….
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More and more investment professionals are able to benefit from OTAS’ unique portfolio and trading analytics as we continue to expand our distribution breadth through channel partnerships with integrated front-end OMS & EMS providers and Financial Analysis solution vendors. Our global reach to both Buy and Sell Side clients is now more accessible than ever before.

We have created bespoke solutions with some of the leading trading infrastructure players providing tight integration with their key client-used components.

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Our suite of applications are also embedded within Thomson Reuters EIKON product, the collaboration of which has created an analytically differentiated and highly economic alternative to legacy desktop competitors who endeavour to replicate an OTAS-style offering.

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See first hand how Eikon users benefit from integrated Core portfolio analytics via this short online video here

Curious to find out if OTAS analytics are available on your desktop via an existing provider ? Get in touch at otassales@otastech.com.….chances are we are already talking to them !

 

 

Today there will be a few Hong Kong large cap names releasing earning results and one of them is Ping An Insurance (2318 HK). It is worth noting that yesterday before the Hong Kong & Shenzhen Connect announcement, the northbound net buy was the highest in one year record and that Ping An Insurance was the top buy name among all the stocks.

Today Ping An Insurance is trading slightly lower ahead of its results, and it could just be a technical pull-back from profit taking from yesterday. It is interesting to see that Ping An Insurance’s implied volatility volume has risen significantly as seen from the yellow triangle displayed below. Note that when Ping An Insurance’s implied volatility volume spiked up last three times on January 12th, April 13th and July 15th this year, its share price always reacted strongly.

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Ping An Insurance – Implied Volatility Summary :

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Ping An’s implied volatility high volume signal on January 12th, April 13th and July 15th this year, and the current high volume signal:

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Ping An Insurance share price’s responses on the days where it had implied volatility volume spike:

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OTAS has fired a Bollinger Band (-) signal 4 days ago and on average the stock might generate 5.0% return over the following 20 trading days. Perhaps it could now be a good time to add positions before the results come out?

We have written a lot about using implied volatility as the measure of how equity markets will react to supposedly high risk political events, including Brexit and the US Presidential Election. This week, Institutional Investor has been good enough to publish our article making precisely this point. Today, however, I want to focus on corporate credit and its importance in determining the success of central bank policy.

Once again I am grateful for outside help, in this instance EvergreenGK for pointing out when and why “Don’t fight the Fed” works. The crux of the argument is that our mantra should really be “Don’t fight the Spread“.

The message from implied volatility in equity markets is that stocks and shares are set fair for the next three months at least, which takes us to the eve of the Presidential election, supposedly the most polarising event in living memory. Equity investors are relying on volatility-crushing central bank interventions to maintain an upward trajectory to equity markets.

Evergreen notes that the early 1930s, the start of the 2000s and mid-2008 to early 2009, were all periods of expansionary monetary policy and terrible stock market performance. If you hadn’t fought the Fed on those occasions, your portfolio would have come-a-cropper. The signal to break from orthodoxy was the rise in corporate credit spreads, because investors considered the risk of companies defaulting to be so great that no authority could do anything about it. This proved to be the case for periods of time that we now call the Great Depression, the bursting of the Dot-Com Bubble and the Global Financial Crisis.

So to today and the five-year credit default swap for the average large cap US company as an indicator of risk for equities. The low point of the median CDS was June 2014 and there has been a steady rise since April 2015. This coincides with total global trade by volume (not value) starting its decline; hard evidence that the trend towards globalisation ended well before protectionists were the only choice for the White House.

Average 5Y CDS for US Large Caps

Average 5Y CDS for US Large Caps

I have shown the chart over a five year period. What this highlights is that corporate credit risk is now very close to the average level over that period and below levels seen in 2011 (thus well below extremes three years earlier). The high point of central bank potency has passed, because the links between money and trade, a primary conduit of long-term global growth, are just too tenuous. What central banks appear to have done however, thanks to the ECB’s intervention in February, is cap the level of risk for now.

EUR CDS

Average 5Y CDS for European Large Caps

The trends for large European corporate credit are similar to those in the US. Average credit costs are 13% higher in Europe, despite US policy rates being above those in Europe. This means that the risk of companies defaulting is greater than in the US, even though the ECB has been buying corporate debt directly since June.

This week the Bank of England announced that it would purchase up to £10bn of corporate debt. The rationale for this is that it will do more to make investors buy other corporate securities (i.e. equities) than if the Bank simply purchased more gilts. Also, with the cost of debt reduced, companies should issue more debt. It remains to be seen whether this has any impact on corporate investment, but recent history suggests that it will boost share buybacks and M&A.

UK CDS

Average 5Y CDS for UK Large Caps

Credit risk in the UK is higher than both the US and Europe. The highest risk is for mining companies, followed by supermarkets and then financial companies. The issues with each of these industries pre-dates Brexit by some way, although as we argue in the Institutional Investor article, the rapid response to Brexit by the Bank of England will only exacerbate the woes of banks and insurers. The UK economy is peculiarly dependent on financial industries.

The success of central banks in holding down corporate credit costs may well determine whether you should be “fighting the Fed” or going with the flow. OTAS presentation of corporate credit is relevant because of the deep statistical analysis that sits behind every chart and table and in the flags that alert you, stock-by-stock, to significant credit events. You can stare at other screens for hours if your firm buys the data feeds, but without the statistical significance, it’s all just noise.

Overnight the crude oil price settled below $40, meaning the price has pulled back 20% from $50 to below $40 within two months. China’s largest offshore Oil and Gas producer CNOOC (883 HK) issued a profit warning six days ago, citing that it is likely to make a greater than expected first-half loss of $1.2bn. Behind the headlines however, there are concealed opportunities highlighted by OTAS this morning, where a few positive signals have flagged with the stock down 10% from the recent high.

The implied volatility of CNOOC relative to the industry has decreased to 0.90 from 0.93 last month, and remains below the industry average. Month-on-month implied volatility is down 7%. In general, declining implied volatility means greater certainty and may lead to a firmer share price.

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While the share price has dropped 3.7% in the past month, EPS momentum has increased by 9.25% despite the recent profit warning. In fact, CNOOC’s EPS momentum has picked up from a negative three months ago into a positive in the last two months.

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EPS Momentum Chart (past 1 year)

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EPS Momentum Chart (past 6 months)

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The 12 months forward dividend of 3.38% remains relatively high within the sector. Peers such as Petrochina ‘H’ and China Oilfield Services ‘H’ yield only 1.92% and 0.84% respectively on a 12 months’ forward basis. CNOOC’s dividend payout is far greater than that of Petrochina and it is a signal that management is relaxed about a period of temporary earnings weakness, which in any case appears to be over.

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