Speculative Punts Attract Capital. SPACs
October 11, 2020 – Weekly comment
My note last week was titled “Singing the Blues” and I added a great Albert King youtube, Born Under a Bad Sign. (“If it wasn’t for bad luck, I wouldn’t have no luck at all” ). For those that missed it, here’s the link. That one reminds me of going to Kingston Mines on Halsted long ago to watch live blues to the early hours in a smoky bar.
Of course, the topic of the note was much less stimulating. It concerned trade flows into blue and gold midcurve puts. Steadily building buys of puts and put spreads in Dec, March and June expiries in 3E and 4E were punctuated on Friday with a 110k volume put spread versus call spread: Bought 3EH 9912/9900ps vs Sold 3EH 9975/9987cs for 0.25, and 0.5 traded as well. EDH’24, the underlying contract, settled 9946.5. The put spread settled 1.75 and the call spread at 1.25. Delta of -0.15. On the surface, one might conclude it’s not particularly compelling, if the call spread fills in, total loss is 12.75 bps and if the put spread fills, then make 12.25. However, the high in this contract has been 9969.5 in August, while it was 9850 in February, prior to emergency easing in March. Open interest in 3EH puts almost doubled on Friday to 480k, with a net increase of 216k on Friday.
Over the week, there was a lot more commentary about curve steepening, and indeed 5/30 ended the week pretty much at the year’s high of 124 bps. On the Eurodollar curve, the red to gold pack spread (2nd to 5th year forward) settled at a recent high of 51.75. High settle of the year has been 62. For context, at the end of 2016 it was just over 100 bps and at that time 5/30 had spiked to 140. Sentiment is slowly shifting to the idea of an inflation premium coming back into the market, or concerns about long end supply, or maybe both.
However, what I want to turn the conversation to is something I noticed in the Fed minutes released this week, and relate it to the broader financial landscape.
Let’s start with the Fed minutes. There is always a section called ‘Staff Review of the Financial Situation’. It’s just exactly how it sounds. Dry. No embellishment. In a way, this how I would like ALL news to be, just a straight reading of the facts, without bias. For policy implications, it’s probably best to read the sections pertaining to “Participants”, the analysis of actual board members. I find that sometimes there are glaring disparities between the staff descriptions and sections attributed to participants. The Staff also provides a Review of the Economic Situation and Outlook. Don’t ignore the guy with the red stapler.
Anyway, here’s the line that caught my eye. “The near-dated implied volatility on 10-year Treasury securities was little changed over the intermeeting period and remained near the bottom of its historical range.” While the staff commonly refers to conditions and volatility in the treasury market, and always mentions VIX, I hadn’t previously noticed such specificity with respect to the ten-year note. We all know that the MOVE index has made historic new lows. It’s almost as if the Fed is saying, “We’ve managed to compress the price of insurance premiums to rock-bottom lows in the face of significant uncertainty.” I personally don’t think that’s a healthy development.
Later in the minutes: “In their comments about inflation, participants noted that consumer prices had increased more quickly than expected in recent months and that market-based measures of inflation compensation had increased moderately over the intermeeting period, although they remained low.” In other words, we’ve slightly misjudged inflation, and the market is telegraphing a change, but… we’ve managed to compress volatility. Later: “Additionally, a couple of participants indicated that highly accommodative financial market conditions could lead to excessive risk taking and to a buildup of financial imbalances.”
The table is set. Last week Chicago Fed’s Evans said on BBG TV, “We’ve got to overshoot for sure… I would be quite pleased if we could get inflation, core inflation, up to 2.5% for a time.” He added, “I think we are going to have lower for longer interest rates for quite some time, and it will probably be uncomfortable for many people.”
Low vol and low rates shifts investors out to the slender branches of the risk tree. This dynamic is embodied by the trend of listed SPACs, or Special Purpose Acquisition Companies. According to Bloomberg, “More than 100 of these blank-check companies have gone public this year, raising more than $40 billion on US exchanges, more than half the total raised in all previous years combined.” The story goes on to say, “The entities provide a way for businesses to go public without going through an initial public offering.” While a mutual fund may target a specific investment theme, and ETFs specific sectors, the idea of a public “blank-check” acquisition group engaging in private deals to juice returns strikes me as being mismatched in terms of both liquidity and time. Investors may not be attuned to the true characteristics of these SPACs. By the way, Vincent Deluard notes that there are now more ETFs than stocks listed on the NYSE and Nasdaq. (Thanks GC). The VIX eased to 25 this week, -2.63 and the lowest since late August, but the interconnectedness of products makes me wary at these levels.
My own personal SPAC is an investment in a tattoo removal company that has developed an alternative (cheaper, safer) method. They’re still looking for funding. If anyone’s interested contact me and I will point you in the right direction. Of course, potentially high reward means high risk; capital can easily evaporate.
Speaking of the possibility of vanishing capital, Illinois continues to teeter on the brink of junk. “…S&P found Illinois faces at least a 5% budget gap for the current fiscal year 2021, even if the progressive tax is approved. The rating agency also warned because of rising debt and continued unbalanced budgets, “Illinois could exhibit further characteristics of a non-investment-grade issuer.” In other words, the state of Illinois is at risk of becoming the first “junk”-rated state in U.S. history. All three major ratings agencies currently put Illinois just one notch above junk status with a negative outlook, indicating further downgrades could come soon.
Finally, here’s a 14 second video clip that might make you feel a little bit better about the robots controlling the market.
CPI Tuesday, PPI Wednesday, Philly Fed Thursday, Retail Sales and Industrial Production Friday.
| 10/2/2020 | 10/2/2020 | chg | ||
| UST 2Y | 13.1 | 15.1 | 2.0 | |
| UST 5Y | 28.3 | 33.3 | 5.0 | |
| UST 10Y | 69.4 | 77.2 | 7.8 | |
| UST 30Y | 148.2 | 157.4 | 9.2 | |
| GERM 2Y | -70.9 | -71.4 | -0.5 | |
| GERM 10Y | -53.6 | -52.7 | 0.9 | |
| JPN 30Y | 60.3 | 63.2 | 2.9 | |
| EURO$ Z0/Z1 | -3.0 | -0.5 | 2.5 | |
| EURO$ Z1/Z2 | 6.0 | 9.5 | 3.5 | |
| EURO$ Z2/Z3 | 13.5 | 15.5 | 2.0 | |
| EUR | 117.17 | 118.27 | 1.10 | |
| CRUDE (active) | 37.34 | 40.91 | 3.57 | |
| SPX | 3348.42 | 3477.14 | 128.72 | 3.8% |
| VIX | 27.63 | 25.00 | -2.63 | |
https://www.federalreserve.gov/monetarypolicy/fomcminutes20200916.htm
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