Goldman Is Turning Increasingly Bearish On Junk Bonds

As we reported at the time, back in March in what was the first shot across the junk bond bow, Goldman downgraded the weakest cohort of high yield, CCC-rated bonds, to underweight from neutral and upgraded BB-rated bonds to neutral from underweight, while keeping an overweight recommendation on the "median", or B-rated bonds.

As shown in the exhibits below, and as Goldman"s chief credit strategist Lotfi Karoui admits, the performance of said rating allocation has been rather mixed.

As Goldman further writes, in some semblance of normalcy and logic, while CCC-rated bonds have underperformed their beta to both B and BB-rated bonds, B-rated bonds have been steadily underperforming their BB peers since mid-May. More granularly and as shown by Exhibit 3, the single B bucket has also accounted for the largest share of bonds that has suffered price declines of more than 5% since mid-May.

Conversely, single-Bs have also accounted for the smallest share of bonds that had more than 5% of price appreciation over the same period. The underperformance of B-rated bonds within the largest movers since mid-May, both up and down, reflects the growing fundamental challenges in many large capital structures in the Wirelines, Media, Energy, and Retail sectors.

So nearly half a year after its last rating revision in the sector, overnight Goldman"s Lotfi Karoui has once again revised his outlook on what has been on of the biggest winners from central bank intervention in capital markets, namely the junk bond space, and has turned even more bearish on the lower quality segments while boosting its outlook for near-IG paper, to wit: "shifting to a more defensive HY rating allocation: Overweight BBs vs. Bs and CCCs.  We upgrade BBs to overweight from neutral, downgrade Bs to underweight from overweight, and maintain our underweight recommendation in CCCs."

What is more notable, is that as justification for his bearish shift, Karoui points out that the fundamentals are starting to get downright ugly:

This allocation reflects a more defensive posture in addition to the lack of fundamental upside for many large B-rated issuers. For CCC-rated bonds, we continue to think the high exposure to secularly challenged sectors coupled with limited scope for fundamentals to improve still warrant an underweight allocation.

Why does this matter? Because for the past 18 months, or since the ECB launched its CSPP corporate bond monetization program, fundamentals have not mattered as investors snapped up any piece of paper, the worse the better, frontrunning the ECB"s own efforts to push up junk prices to record levels. But between the ECB"s upcoming tapering, and today"s Goldman recommendations, fundamentals - that anachronism that was obviated by nearly a decade of direct central bank intervention - may once again matter.

Here are the details:

Turning more defensive across the HY rating spectrum: Overweight BBs, underweight Bs and CCCs. We upgrade BB-rated bonds to overweight from neutral, downgrade Bs to underweight from overweight  previously, and maintain an underweight recommendation on CCCs. This allocation reflects a more defensive posture in addition to the lack of fundamental upside for many large B-rated issuers. For CCC-rated bonds, we continue to think the high exposure to secularly challenged sectors coupled with limited scope for fundamentals to improve still warrant an underweight allocation.

For context, Retail and high-cost Energy and Metals and Mining companies account for roughly a little less than a quarter of the combined market value of the CCC bucket (inclusive of non-index eligible bonds). We would however emphasize the  holistic nature of our cautious view, which ignores potential opportunities at the issuer-level.

No matter the reason behind Goldman"s cold feet, investors are still clearly living in a world in which central bankers have it all under control as the latest Barclays aggregate HY Corp yield index shows...

These Are The 10 Most Crowded Long And Short Trades According To UBS

In this market where fundamentals long ago ceased to matter, and where positioning remains one of the few remaining sources of alpha, investors have been focusing on lists showing the most over and under-owned stocks. However, contrary to the narrative that the most heavily owned stocks outperform the most shorted, or underowned ones, and vice versa, recently BofA calculated that for the third year in a row, "the Top 10 most overbought stocks have trailed the S&P for each of the past three years, while the Top 10 "most neglected" stocks outperformed the S&P on average by 11.6%."

This is what BofA"s quant team found:

As flows from active to passive funds have accelerated, one strategy that has worked unusually well for the last several years is a simple positioning trade of selling the 10 most overweight stocks and buying the 10 most underweight stocks by active managers. This single trade has yielded over 16ppt of alpha year-to-date. And implied derisking/ outflows on Brexit alone have been fierce, with the same strategy generating 5.2ppt of alpha just since last Thursday’s close. Even if Brexit’s impact on funds is limited from here, we believe that crowded stocks will likely continue to underperform neglected stocks: a whopping two-thirds of US large cap AUM still resides in active funds - there is likely a lot more to go in the rotation from active to passive.

Visually:

As such, a useful trading framework, would be to look at the Top 10 most crowded trades of active managers - on either side of the ledger - and to short the 10 most overweight, while going long the 10 most underweight stocks.

Conveniently UBS has updated its list of the Top 10 most crowded trades, revealing "where are the largest active positions." How does UBS  measure the most active positions?

Using the institutional ownership data provided by FactSet, we form an active trading portfolio by aggregating positions across global active managers. Essentially, we sum up all the holdings in dollar value across all the active managers and calculate the weights of stocks in this active trading portfolio. We then compare this weight with the relevant equity index benchmark to form the active weight.

So, without further ado, here according to UBS are the Top 10 most crowded long and short trades, and not surprisingly, it"s all tech among the top 5 longs, which include Google, Alibaba, Amazon (a jump from 8th spot as of the last ranking), Facebook and Visa (with AAPL sliding into 6th spot), while on the short side one name stands out: Tesla in the perennial top slot, which may explain why no matter how bad the news, even the smallest glimmer of hope, whether a tweet from Elon Musk or an upgrade, prompts a sharp squeeze, like today for example.

Based on UBS data, this is how these two baskets have performed on a YTD basis:

Finally for those wondering, here is a breakdown of how levered hedge funds are as mid-July courtesy of JPM Pribe Brokerage. It will probably not come as a surprise that every single category has increased its leverage on a 3M, 6M and 12M basis.

European Stock Markets See Best Start To Year Since 2013

European stocks were panic-bid at the open overnight as hungover New Year"s Eve revelers (absent Brits and Swiss who were still on holiday) bought Italian banks, German utilities, and Spanish industrials following the better than expected manufacturing PMIs across most nations. EuroStoxx 50 gained 0.6% - thanks to a spike near the open - for the best open to a year since 2013.

The action was all at the open following a knee-jerk lower in EURUSD (snapping below 1.0500)...

But notably across most of the individual exchanges, stocks were sold into the close...

Finally, as Bloomberg reports, for Stephane Barbier de la Serre, a strategist at Makor Capital Markets in Geneva, the consensus for Europe’s economic growth this year remains very cautious, which means any positive surprises in macroeconomic data may spur further gains in stocks:

“There’s a lack of commitment and conviction,” de la Serre said. “Most institutional investors are still underweight European equities, betting on a pull-back after the rally of the past few weeks, so we could see a bear trap in the first weeks of the year.”