What is driving the markets?

According to latest Q2 SEC 13F filings, institutional investors (hedge funds, pension funds and endowments and banks) increased their positions in 4 out of 10 S&P economic sectors, namely energy, material, information technology and utilities. Most notably, the 3.0% energy sector incremental increase over the 1st quarter, and significantly underweight in financial and consumer discretionary (see the chart "% weighting changes from 1st Q" on the right panel.) The dramatic market sell-off we experienced lately, especially last two sessions, caught many people by surprise, especially the pounding on technology sector and small cap sectors.

If we compare the institutional investors' holdings and sector performance, we would not have much difficulties to find that current market behavior may be largely driven by the asset allocations and "locking-in" gain on the 1st half's best performers, namely energy, materials and technology. As the chart on the left shows that energy and material sectors performed the best, especially energy as everybody witnessed in the 1st six months this year . Immediately entering the 3rd calendar quarter, the physical commodities markets start to crumble, and also equity markets. From the chart on the left, we can see that the best performance of four sectors in the first six months, i.e., energy, material, technology and utilities switched the positions with the worst four sectors (financial, consumer discretionary, staples and health care) in last two months. The speeds of market declines in the last few days seems to suggest that "big guys" were rushing to the emergency exits. And the rumors of hedge funds liquidated positions certainly added fuel to fire.

data source: Bloomberg

What history tell us about “Sell in May and Go Away”?

US stock market has experienced one of the best first four-month performance over the last four decades, produced 17.5% price return comparing to 19.1% in 1987. It is the third best price return for S&P 500 index since 1950; the top four-month performance belongs to 27.3% in 1975 as the stock market recovered from a severe bear market in 1973-1974 when the index nosedived more than 42% in two years. With calendar flipped into May and onto summer season of sun, beaches, most likely we would hear a lot of about old Wall Street saying “Say in May and go away” in the media. Moreover, primarily because of the unprecedented nature of speed and magnitude of the current market rally against the backdrop of weakening macroeconomic and corporate earnings backdrops during the period. Sell in May and Go Way has delivered 6 times more return Historically, the six months between Nov-April frequently experienced extraordinary stock market performance than the six months between May to Oct...

MBS spread widen at historical levels

The turmoils at FNM and FRE created great anxieties and opportunities for both equities and debt TRADERS. The newly passed housing rescued packages by the Congress and signed the President essentially changed the "implied" to "explicit" US government backings on both quasi agency's outstanding debts. Their spreads to US treasuries have tightened in last few weeks. However, the most liquid 15 yr and 30 yr fixed MBS from Freddie and Fannie were under great pressures in last few days. Using 10 yr swap rate as benchmark, FNCI (15 yr Fannie MBS TBA) was priced to 5.50% with spread of 78 bps, that was 4 times of historical 10 year average (see the first chart). FNCI was traded at the cheapest level since 1998. The 78 bp spread to the swap was about four sigmas of the mean. FNCL (30 yr Fannie MBS TBA) was also trade at the lowest level that we have not seen in the last decade (second chart). Comparing to other investment alternatives, current fixed MBS prov...

Negative Swap Spread

One of most intriguing event, which barely got any attention in the market, was that, for the first time in the history, 30 year USD swap spread dropped into negative territory today. The US treasury 30 year bond traded at 4.027% and the same maturity US dollar swap traded at 4.051%, i.e, 30 year swap spread was about -2.4 bps (see attached Bloomberg chart below) . The 30 year swap rate only go back to early 1994 in Bloomberg data base, in the last 14 years, swap curve was always and should traded at discount to the treasury benchmark, "risk-free" bogey. So what is mean for the equity and credit market? Or most importantly, is the swap market trying or pricing the much deep recession or an early signal of Japanese-style deflation market has feared in 2003? Is the US treasury credit quality put into challenges? Or just the abnormally due to temporary market forces? Isn't the market facing the greatest CREDIT crisis we ever face since the Great Depression? Should we expect...

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