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It's the high-yield space everyone is watching. The biggest high-yield ETF, iShares High Yield Corporate (HYG), is down 0.3 percent today, over two percent this week., near a 12-month low.
Some of these declines are clearly due to fundamental factors...principally a concern about higher rates.
But some of these issues are likely tied to liquidity. It's been well-known that bond dealers have pulled back on inventories of bonds. This process has been going on for several years.
A tighter inventory means that if someone wants to pull back and sell something, prices will have to drop.
That leads to a desire by some to try to second guess the market by selling ahead of perceived heavier volumes.
Why are inventories tighter?
First, the banks had big losses during and after the financial crisis. You lose a couple billion dollars in bonds and you get more cautious.
Second, regulatory restrictions have gotten much tighter (Dodd-Frank) around risk-taking and capital levels.
Finally, large sections of natural buyers and sellers--proprietary trading desks run by large brokerage operations--have been mostly shut down due to Dodd-Frank. That is a lot of trading capacity that has been taken out of the market. That can make a smooth functioning of the market much more difficult.
Finally, you don't have to be an investment genius to realize that valuations have been stretched by the desperate "reach for yield."
Let's be honest: There has been a lot of "tourist investors" in the high-yield space in the last few years. These are investors who just want higher yield, no matter what. In the past, investors who needed high yield would have hired a bond manager or carefully looked at a company's prospects before buying a junk bond. Today, you can just invest in an ETF. You don't need to know much.
So what? These "tourists" are much quicker to pull money from an ETF. And that leads to others trying to front-run those concerns, as described above.
A number of factors appear to be moving markets around on Thursday. In addition to the usual rumors of a "large seller" hitting the sell button, there are at least two developments that are getting a lot of attention:
1) Richard Fisher, the head of the Dallas Federal Reserve, said early Thursday that the Fed may start raising rates in the spring of 2015—earlier than most expected. Of course he is a hawk, but the comments were widely passed around, and he seems to be getting a bit louder as he gets closer to stepping down next April.
In particular, Fisher said "We're beginning to see extreme risk taking in the junk bond markets." Not surprisingly, high yield exchange-traded funds (ETFs) like the iShares High Yield ETF and the SPDR High Yield ETF are down about a half-percent (very large decline for a bond fund) on heavy volume.
Pockets of softness in the market for initial public offerings (IPOs) is the order of the day.
Earlier, Travelport Worldwide, a travel e-commerce company, priced 30 million shares at $16, the high end of the $14–$16 price talk. CONE Midstream Partners, a master limited partnership (MLP) formed by Consol Energy and Noble Energy, priced 17.5 million shares at $22, above the $19–$21 price talk. This one pays a 4.25 percent dividend.
On the other hand, oil and gas firm Vantage Energy postponed its IPO. Why?
I said last week that the real test for the initial public offering (IPO) market would be the ability to absorb the more than $7 billion in IPOs and secondaries coming this week in the wake of Alibaba.
Well, the early results are in, and they are decidedly mixed. Two of the four IPOs priced this week have done so below the expected range. Consider the following:
The Shanghai Composite was up 0.9 percent, but most of the rest of Asia was down as after China's Flash Manufacturing Purchasing Manager's Index (PMI) came in stronger than expected , at 50.5 vs 50.0. New orders also rose to 52.3, up from 51.3.
That helped the Australian stock market rise 0.9 percent. Base metals, however, are mixed: copper and aluminum are down, while nickel is rising. Europe, however, is weak across the board, and that fed into early weakness on Wall Street. PMIs there showed clear signs of a slowdown.
It's a lousy day for global growth fans.
It's one of those days where the market is worse than the indices indicate…5 to 1 declining to advancing stocks at the NYSE, with notable weakness in Energy, Consumer Discretionary, and particularly commodity names.
You also get iron ore and steel stocks weak...big names like BHP (BHP) are down three percent or more.
Global growth slowdown concerns are also weighing on emerging markets...
In a broader context, we are also seeing weakness in momentum names like Chinese internets and social media stocks.
So what's causing this jitteriness? Not much at all. Chinese Finance Minister Lou Jiwei, speaking last night at the G20 meeting, implied that a major stimulus program might not be forthcoming. There's some concern that the manufacturing PMI to be released tonight might be weak.
But that is pretty thin gruel for a market selloff.
My sense is a lot of this will change once Q3 earnings start to come in. Overall, Q3 earnings look pretty good. The Street estimates are around 6 percent growth, that is what we had last quarter and we ended up with almost 10 percent growth in earnings, another record.
In my mind, it is still basically a Goldilocks scenario. I see nothing on the tape that suggests this is the beginning of a major selloff. We are continuing to grind around 2,000 on the S&P 500.
Inflation? Not here, not yet. Big-time economic growth? No. Fed worries? The Fed is usually a bigger threat to stocks when inflation is around than when they are responding to slightly stronger growth.
If the usual pattern holds, a few more days like this and buyers will likely come out of the woodwork.
Now that Alibaba's record-breaking offering is out of the way, global markets are gearing up for a raft of new recruits. Another wave of initial public offerings (IPOs) is building this week.
Reuters notes a wave of 12 new flotations expected in China this week. In London, several big names may go public shortly, including shoemaker Jimmy Choo, and home builder Miller.
The test for the broad IPO group will be Rhode Island based regional bank Citizens Financial, a spin off of Royal Bank of Scotland, which will likely be the second-largest IPO of the year after Alibaba.
Alibaba (BABA) priced at $68, opened at $92.70, closed at $93.89. But the most interesting part of the process is the price discovery mechanism. How do you decide what price you should open at?
In the case of Alibaba, there was enormous demand right at the outset. In fact, there were essentially NO sellers at the initial price of $68.
The initial price indication was given a little after 9:50 a.m. ET: Roughly 25 million shares paired off (equal number of buyers and sellers) at $80-$83. Even at that price, there were bids for millions of shares more where there were no corresponding sellers.
What to do? Increase the price. The next two indications were stepped up in $3 intervals: $82-$85 and $84-$87. Then about 10:43 a.m., the indication began to tighten to a $2 band: $86-$88, and then the indications starting coming more frequently:
By the time of the final indication, there were only a few million shares that had not been paired off. This was a good indication that we were getting close to opening.
But the stock did not open until 11:53 a.m., when 48 million shares were sold at $92.70.
Why did it take 25 more minutes from the time of the last indication to open? Because there were buyers sitting around watching the action, with intention to buy, who didn't want to act until the last minute, for whatever reason. Their last-minute bids, put in just as the stock was ready to open, prolonged the process.
In other words, it's a dynamic process. It is changing while you are watching it.
It's a great study in Game Theory, the study of watching multiple agents all acting in their best interests and responding to incentives (lower price if you're a buyer, higher if you're a seller), while trying to anticipate what everyone else will do.
OK, Alibaba doesn't cure cancer, but you'd think so with some of the theories going around.
I noted during my 9:35 a.m. ET hit that the stock market open was unusually strong: All major indices opened up, all 10 S&P sectors opened up, and both the Dow Industrials and Dow Transports were at new highs (Dow Theorists rejoice).
The most logical reason we would have this mild lift is that traders are unwinding hedges that were put on ahead of the Federal Reserve meeting that ended yesterday.
What can markets expect when Alibaba starts trading?
This is the biggest question on trading desks for the past several days. I don't make predictions on where stocks will trade, but there are several reasons I am optimistic that Alibaba—at whatever price—will open to the upside and stay there on its first day. Here are a few reasons why, put simply:
1. It's almost impossible to get the kind of numbers Alibaba has, anywhere. On all levels that matter: scale, growth, and margins, Alibaba is off the charts. It owns 80 percent of the Chinese e-commerce market, has seen 46 percent revenue growth in the most recent quarter, and has meaty margins of 54 percent.
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