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  • Peak Risk

    Article by John Serrapere
    Investment Analyst & Strategist
    Foster Holdings, Inc.


  • #2
    Are we missing a link or a file here?

    Comment


    • #3
      For two reasons Mr. Serepere's commentary is highly disturbing to me.

      The first is because EJ prefaced it with, This is likely the most important analysis that iTulip.com has published in its seven year history.

      The second reason it disturbs me is that I do not comprehend most of it.

      Example: The wide credit spreads depicted in Figure 1 were warning investors to underweight or hedge assets with high correlations to the S&P 500 and high correlations to credit risk, while Figure 2 indicates the contrary.

      As I understand the article, the credit spreads at the end of April 2006 were narrow (169 bps) as they were at the end of January 2000 (165 bps). In contrast to the Serepere's quote above, it seems that the narrow credit spreads existing a few days ago are warning investors to underweight or hedge assets with high correlations to the S&P 500 and high correlations to credit risk. Would that not be easier to understand if I am understanding it?

      What assets have high correlations to credit risks?

      Jim
      Jim 69 y/o

      "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

      Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

      Good judgement comes from experience; experience comes from bad judgement. Unknown.

      Comment


      • #4
        Where can one find the yields on Baa Corporate Bonds?

        Jim
        Jim 69 y/o

        "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

        Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

        Good judgement comes from experience; experience comes from bad judgement. Unknown.

        Comment


        • #5
          Where can one find the yields on Baa Corporate Bonds?

          Jim
          From time to time I have come across someone describing one technical indicator or another. Many of these have seemed useful, but the initial problem for me was not having the data in order to be able to follow the indicator without relying upon someone else. Because no one answered my question above, thus saving me a lot of time searching, I had to search myself.

          One can find the daily yield on TNX in numerous places, but I have not seen BBB (BBBdesignates the same grade bonds as Baa) corporate bond yield data anywhere I could get it for free. I found http://www.bondsonline.com/Todays_Market/.

          If anyone wishes to follow the yield spreads between the 10 year BBB and TNX as described by John Serrapere, you can access that site. You must scroll down to find a blue graph on the left which charts the AAA and BBB yields. If you point to the chart you should get a pop up window that shows the yield for the grade of bonds at the various maturities. Getting the yields pop up might take pointing to it several times, and I could only get it to work using IE 6.0. It would not work with Mozilla/Firefox 5.0.

          Serrapere said [Startquote]The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006.[/QUOTE] Actually if you do it that way the spread is a minus number. Yesterday, 4/26, the TNX was 5.052% and at the above site the BBB 10 year yield was 6.49%, so the spread would be a minus 1.44%. The BBB 10 year bond was yielding 144 basis points more than the 10 year Treasury note, so this is even a tighter spead that Serrapere noted in his article on iTulip--this assumes I have not screwed up anywhere.

          This indicator strikes me as one I wish to follow.

          Jim
          Jim 69 y/o

          "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

          Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

          Good judgement comes from experience; experience comes from bad judgement. Unknown.

          Comment


          • #6
            Where can one find the yields on Baa Corporate Bonds?

            Jim
            From time to time I have come across someone describing one technical indicator or another. Many of these have seemed useful, but the initial problem for me was not having the data in order to be able to follow the indicator without relying upon someone else. Because no one answered my question above, thus saving me a lot of time searching, I had to search myself.

            One can find the daily yield on TNX in numerous places, but I have not seen BBB (BBBdesignates the same grade bonds as Baa) corporate bond yield data anywhere I could get it for free. I found http://www.bondsonline.com/Todays_Market/.

            If anyone wishes to follow the yield spreads between the 10 year BBB and TNX as described by John Serrapere, you can access that site. You must scroll down to find a blue graph on the left which charts the AAA and BBB yields. If you point to the chart you should get a pop up window that shows the yield for the grade of bonds at the various maturities. Getting the yields pop up might take pointing to it several times, and I could only get it to work using IE 6.0. It would not work with Mozilla/Firefox 5.0.

            Serrapere said

            The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006.
            Actually if you do it that way the spread is a minus number. Yesterday, 4/26, the TNX was 5.052% and at the above site the BBB 10 year yield was 6.49%, so the spread would be a minus 1.44%. The BBB 10 year bond was yielding 144 basis points more than the 10 year Treasury note, so this is even a tighter spead that Serrapere noted in his article on iTulip--this assumes I have not screwed up anywhere.

            This indicator strikes me as one I wish to follow.

            Sorry, I messed up the above post.

            Jim
            Jim 69 y/o

            "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

            Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

            Good judgement comes from experience; experience comes from bad judgement. Unknown.

            Comment


            • #7
              Where can one find the yields on Baa Corporate Bonds? Jim
              Daily Data from 1986: http://research.stlouisfed.org/fred2/series/DBAA/119

              Weekly Data from 1962: http://research.stlouisfed.org/fred2/series/WBAA/119

              Monthly Data from 1919: http://research.stlouisfed.org/fred2/series/BAA/119

              Comment


              • #8
                zeebie,

                GOOD MAN, I presume you are a man. If you are, and were I with you, I would probably hug you. If you are a woman, I would definitely hug you.

                What you pointed out is a great data source.

                JIm

                Jim
                Jim 69 y/o

                "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                Good judgement comes from experience; experience comes from bad judgement. Unknown.

                Comment


                • #9
                  The quotes below are taken from:Guest Commentary - May 26, 2006
                  Peak Risk by John Serrapere

                  Recent credit spreads are the narrowest since 1984. The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps, while the long-term average spread has been 546 bps and the all-time widest spread was 1126 bps on October0, 2002. Under current conditions, corporations must grow free cash-flow, and that is tethered to earnings growth. The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006, which is 40%-63% below normal, as shown in Tables 2 and 4 below, and a mere 4 bps wider than it was at the end of January 2000.

                  Tight spreads are odd given a flat yield curve, higher all-items inflation, rich equity valuations, and an aged business cycle. Narrow credit spreads under these conditions have been indicative of extreme risk. The stakes for high credit risk in this cycle are especially serious because of severe consumer indebtedness and structural financial imbalances resulting from U.S. domestic trade and federal deficits. The wide credit spreads that happened between February 2000 and October 2002 depicted in Figure 1 were warning investors to underweight or hedge assets with high correlations to the S&P 500 and high correlations to credit risk. Narrow credit spreads that happened between October 2002 and December 2005 as shown in Figure 2 indicate the contrary.
                  Based on my data on the TNX which has been downloaded initially from Worden.com, and updated daily for a long time using the closing quotes of TNX from schwab.com, and Baa data jsut downloaded from http://research.stlouisfed.org/fred2/series/DBAA/119, I find some discrepancies in what Mr. Serrapere said in his commentary above and my data.

                  The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps,
                  My data show the last time the Baa-TNX was 345 bps or more was on 12/31/02 when it was 349 bps. That long ago, over 4 years ago, does not strike me as recent.

                  the all-time widest spread was 1126 bps on October0, 2002.
                  There is something significantly wrong with the above quote besides the typo that obscures the intended day of the month.

                  My data show the highest Baa-TNX spread since 12/30/99 was 395 bps on 10/14/02.

                  The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006, which is 40%-63% below normal, as shown in Tables 2 and 4 below, and a mere 4 bps wider than it was at the end of January 2000.
                  My data show the Baa-TNS spread on 1/27/2000 was 154.5 bps. The lowest spread in April 2006 was 165.5 bps on 4/25, thus 11 bps wider than it was at the end of January 2000.

                  My interpretation of these spread data is likely infantile in perspective compared to Mr. Serrapere's; however, it strikes me that a point he was making is that these low spreads are (may be) precursors to future periods where the spreads will again widen and according to his Figure 1. during such periods of widening spreads one thing that may not do well is the SPX.

                  My data show that the Baa-TNX spread was 150.40 on 3/14/05. That is 4 bps lower than in January 2000, and 15 bps lower than in April 2006. Twenty-six market days after 3/14/05, the SPX bottomed on 4/20/05 at intraday 1136.15, and went on to hit 1326.70 intraday on 5/8/06. So with the Baa-TNX spread at what may be (if my data are correct) its lowest level since January 2000--that is, 150.40 on 3/14/05--the SPX subsequently rose 16.77%, which to me is not a bad gain in a few days less than 14 months.

                  Likely, I am missing something important here, but I do not know what it is.

                  If one takes the times of the two lowest spreads on the Baa-TNS spread since the beginning of 2000, following the first there was a collapse of the market to its October 2002 lows--a loss of 49% over 30.5 months. Following the second low spread of 150 bps 14 months ago, the SPX has risen almost 17%.

                  Had Mr. Serrapere published these same comments at the end of March 2005, they would have appeared to me to be more ominous, at least with regard to the Baa-TNS spreads data, than they are now, but after that the market measured by the SPX had a nice run up. Now, I do not know really what to make of his comments.

                  Where am I wrong?

                  Jim
                  Jim 69 y/o

                  "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                  Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                  Good judgement comes from experience; experience comes from bad judgement. Unknown.

                  Comment


                  • #10
                    Jim,

                    Good job seeking to validate the author's research!

                    I can confirm a few things from what he said:

                    The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006,

                    I show 167.

                    which is 40%-63% below normal, as shown in Tables 2 and 4 below,

                    I'm not sure where he gets this from. I show it is only 20% below average.

                    and a mere 4 bps wider than it was at the end of January 2000.

                    I show 167 now and 168 on the last day of January 2000.

                    The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps

                    I believe he made a mistake here since as I just said, I can confirm his value at the end of April.

                    The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps, while the long-term average spread has been 546 bps and the all-time widest spread was 1126 bps on October0, 2002.

                    I don't have a clue where he is getting these numbers. I checked this back to 1953 and I cannot confirm these values.

                    I found the returns going forward 1-Mth, 3-Mths, and 12-Mths on the S&P 500 for the various spread values. In order to simplify the evaluation, I broke the spreads into groups of 10% each -- decile baskets. Here is what I found for the 12 month forward return:

                    Lowest 5%: 116-148 -- 25.15%
                    Next 5%: 148-152 -- 27.39%
                    Lowest 10%: 116-152 -- 26.23%
                    Next 10%: 152-164 -- 20.40%
                    Next 10%: 164-172 -- 12.71%
                    Next 10%: 172-183 -- 10.47%
                    Next 10%: 183-198 -- 4.07%
                    Next 10%: 98-213 -- 5.85%
                    Next 10%: 213-229 -- 6.48%
                    Next 10%: 229-253 -- 4.62%
                    Next 10%: 253-285 -- -1.23%
                    Top 10%: 285-390 -- 3.52%

                    Based on the above, I would say that the author's comment that:

                    Narrow credit spreads under these conditions have been indicative of extreme risk.

                    Yes and no. Our present value is 168 bps. At this value the historical forward one month return for the S&P 500 is 2.04%, 3.52% for three months forward and 12.71% for one year forward. But the narrow the credit spread, the more likely that the market will bounce back as evidenced by the data compiled above.

                    I'll probably add this data to my own blog so if you are interested drop me an email and I'll give you temporary access to view the data and download the spreadsheet I put together for this study.

                    Comment


                    • #11
                      Emerging Market securities and equities rated B or lower by S&P for earnings and dividnd quality are two expamles of asset with high correlations to credit spreads.

                      Readers should know that this paper was written as an internal white paper for my firm. The paper was addressing hedge fund styles with the advice to underweight styles with high correlations to credit risk. This paper was completed on Apr-20-2006 and revised on May 25, 2006 for itulip.com. Funds that employ the aforementioned securites and high yield bonds and various arb styles (if their bias tends to be too long) also have high correlations to credit risk. Shorts need liquidity more than longs so hedge funds are hurt badly when credit spreads widen.

                      I have a patent pending on a metric, Relative Value at Risk that measures systematic trend risk to the above. Since the fall of 2005 it has been warning of a 1997-1998 like risk for most hedge fund styles.

                      I hope this helps.
                      John

                      John Serrapere

                      Comment


                      • #12
                        The quotes below are taken from:Guest Commentary - May 26, 2006
                        Peak Risk by John Serrapere

                        Recent credit spreads are the narrowest since 1984. The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps, while the long-term average spread has been 546 bps and the all-time widest spread was 1126 bps on October0, 2002. Under current conditions, corporations must grow free cash-flow, and that is tethered to earnings growth. The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006, which is 40%-63% below normal, as shown in Tables 2 and 4 below, and a mere 4 bps wider than it was at the end of January 2000.

                        Tight spreads are odd given a flat yield curve, higher all-items inflation, rich equity valuations, and an aged business cycle. Narrow credit spreads under these conditions have been indicative of extreme risk. The stakes for high credit risk in this cycle are especially serious because of severe consumer indebtedness and structural financial imbalances resulting from U.S. domestic trade and federal deficits. The wide credit spreads that happened between February 2000 and October 2002 depicted in Figure 1 were warning investors to underweight or hedge assets with high correlations to the S&P 500 and high correlations to credit risk. Narrow credit spreads that happened between October 2002 and December 2005 as shown in Figure 2 indicate the contrary.
                        Based on my data on the TNX which has been downloaded initially from Worden.com, and updated daily for a long time using the closing quotes of TNX from schwab.com, and Baa data jsut downloaded from http://research.stlouisfed.org/fred2/series/DBAA/119, I find some discrepancies in what Mr. Serrapere said in his commentary above and my data.

                        The spread from Treasuries to the lowest grade corporate bonds was recently 345 bps,
                        My data show the last time the Baa-TNX was 345 bps or more was on 12/31/02 when it was 349 bps. That long ago, over 4 years ago, does not strike me as recent.

                        the all-time widest spread was 1126 bps on October0, 2002.
                        There is something significantly wrong with the above quote besides the typo that obscures the intended day of the month.

                        My data show the highest Baa-TNX spread since 12/30/99 was 395 bps on 10/14/02.

                        The 10-year T-note minus Baa Yield spread was 169 bps at the end of April 2006, which is 40%-63% below normal, as shown in Tables 2 and 4 below, and a mere 4 bps wider than it was at the end of January 2000.
                        My data show the Baa-TNS spread on 1/27/2000 was 154.5 bps. The lowest spread in April 2006 was 165.5 bps on 4/25, thus 11 bps wider than it was at the end of January 2000.

                        My interpretation of these spread data is likely infantile in perspective compared to Mr. Serrapere's; however, it strikes me that a point he was making is that these low spreads are (may be) precursors to future periods where the spreads will again widen and according to his Figure 1. during such periods of widening spreads one thing that may not do well is the SPX.

                        My data show that the Baa-TNX spread was 150.40 on 3/14/05. That is 4 bps lower than in January 2000, and 15 bps lower than in April 2006. Twenty-six market days after 3/14/05, the SPX bottomed on 4/20/05 at intraday 1136.15, and went on to hit 1326.70 intraday on 5/8/06. So with the Baa-TNX spread at what may be (if my data are correct) its lowest level since January 2000--that is, 150.40 on 3/14/05--the SPX subsequently rose 16.77%, which to me is not a bad gain in a few days less than 14 months.

                        Likely, I am missing something important here, but I do not know what it is.

                        If one takes the times of the two lowest spreads on the Baa-TNS spread since the beginning of 2000, following the first there was a collapse of the market to its October 2002 lows--a loss of 49% over 30.5 months. Following the second low spread of 150 bps 14 months ago, the SPX has risen almost 17%.

                        Had Mr. Serrapere published these same comments at the end of March 2005, they would have appeared to me to be more ominous, at least with regard to the Baa-TNS spreads data, than they are now, but after that the market measured by the SPX had a nice run up. Now, I do not know really what to make of his comments.

                        Where am I wrong?

                        Jim
                        Jim,
                        Made clarifications to John's piece. They are here:

                        http://www.itulip.com/peakriskmay2006.htm#update

                        Please also note John's comment that this work was written originally in late March and early April 2006.

                        Comment


                        • #13
                          I appreciate Mr. Serrapere's corrections and the value of his paper in general.

                          It is above my understanding as to why he chose to interject data on the Treauries versus the Credit Swiss High-Yield Index spreads, when eveything else of which he wrote concerned the 10 yearTreasury Baa spreads.

                          Jim
                          Jim 69 y/o

                          "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                          Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                          Good judgement comes from experience; experience comes from bad judgement. Unknown.

                          Comment

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