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1、November 9,2012,The Credit LineThe liquidity outlook(part 2):Still improving,Credit Strategy Research,Trading liquidity is set to improveWe attribute most of the August 2011 deterioration in trading liquidity tothe escalation of the European sovereign crisis last fall.While none of thefundamental pr
2、oblems facing the Euro area have gotten better,wenonetheless believe that unlike the fall of 2011,the ECB now has thenecessary instruments in place to manage any re-elevation of funding,Charles P.Himmelberg(917)343-3218 Goldman,Sachs&Co.Lotfi Karoui(917)343-1548 Goldman,Sachs&Co.,pressures on the pe
3、riphery sovereigns.Liquidity improves when trading flows are less“macro”We conjecture that trading liquidity has suffered from elevated levels ofsystemic risk because“macro trading flow”is more difficult tointermediate than“micro trading flow.”In August of 2011,for example,wesuspect many market make
4、rs were alarmed by the fact that Europeanbanks were suddenly looking for bids on large blocks of bonds.Coming asit did on the back of the re-escalation of Euro sovereign fears and themuch-discussed collapse of dollar funding for European banks,it wasnatural to worry that even larger blocks of bonds
5、were still to come.Wefind evidence that our measure of“highly correlated flow risk”iscorrelated with our measure of“round-trip trading costs.”When the entiremarket is trying to move risk in the same direction which is typically thecase in face of a rapid escalation of systemic funding concerns such
6、risksobviously increase the riskiness and difficulty of providing market liquidity.This research is focused on investment themes across markets,industries and sectors.It does not attempt to distinguishbetween the prospects or performance of,or provide analysis of,individual companies within any indu
7、stry or sector wedescribe.Investors should consider this research as only a single factor in making investment decisions.For Reg ACcertification and other important disclosures,see the Disclosure Appendix,or go to,The Goldman Sachs Group,Inc.,Goldman Sachs Global Economics,Commodities and Strategy R
8、esearch,2,November 9,2012Why trading liquidity should improveAs most participants in the corporate bond market are well aware,trading liquiditydeteriorated sharply during the first week of August,2011,and remained impaired into thebeginning of 2012.To track such movements in trading liquidity,we use
9、 our measure ofround-trip trading costs(RTTC),which we described in our March 9,2012,publication ofThe Credit Line(“The liquidity outlook(part 1):Better than it feels”).Exhibit 1 displays the history of this index since 2008.The history of the RTTC reveals twoclear patterns.First,that up until Augus
10、t 2011,trading liquidity was showing steadyimprovement in the wake of the shock caused by the Lehman default.And second,thatduring that first week of August 2011,trading costs rose sharply.According to our RTTCmeasure,the median effective trading cost for investment grade credit roughly doubled to4.
11、64 bps by the end of August 2011,compared to its level on of 2.22 bps on the first of thatmonth.And as Exhibit 1 shows,RTTC remained elevated through the first few months of2012 before beginning to normalize.In our March 9 report,we argued that trading liquidity would improve.We have seen aslight tr
12、end better,but a better forecast would have been“sideways.”Our measure oftrading costs has basically been range-bound around the March level of 3.5 bps,from lowsof around 3.0 bps to highs of just over 4.0 bps.We are still far,in other words,from thelevels just above 2.0 bps observed throughout the f
13、irst half of 2011.We continue to think that the market conditions for trading liquidity are set toimprove.This is mainly because we attribute most of the August 2011 deterioration inliquidity to the escalation of the European sovereign crisis last fall,and we think the worstof that crisis is likely
14、behind us(at least through 2013,if not longer).While none of thefundamental problems facing the Euro area have become better,and the recession in theperiphery has in fact gotten worse,we nonetheless believe that unlike the fall of 2011,theECB now has the necessary instruments in place to manage any
15、re-elevation of markettensions arising from funding pressures on the periphery sovereigns.Exhibit 1:Round-trip trading costs(RTTC)have steadily improved since the sharpdeterioration in August 2011 following the escalation of Euro sovereign fears.181614121086420,Nov08,May09,Nov09,May10,Nov10,May11,No
16、v11,May12,Source:Goldman Sachs Credit Strategy,TRACEGoldman Sachs Global Economics,Commodities and Strategy Research,Basispoints,Basispoints,3,November 9,2012Exhibit 2:Round-trip trading costs are sensitive to balance sheet funding costs,876543210,Round-trip trading costs(LHS)Term funding spread for
17、 banks(RHS),500450400350300250200150100,Jul09,Jan10,Jul10,Jan11,Jul11,Jan12,Jul12,Source:Goldman Sachs Credit Strategy,iBoxx,TRACE.In addition to the reductions in systemic tail risks out of Europe(and in part because ofthese reductions),the cost of term funding for banks has fallen fairly dramatica
18、lly.According to iBoxx data,the cost of 3-to-5 year funding for US banks,which had seenspreads to Treasury as high of nearly 400 bps in Dec 2011,have fallen to roughly 140 bps lower than the lows of 2011.And in our view,the cost of balance sheet funding is perhaps the most importantfundamental drive
19、r of the broker-dealer communitys ability to supply market liquidity attighter bid-ask spreads.Exhibit 2 plots our trading cost measure(RTTC)against the iBoxxlevel of 5-7 year credit spreads to Treasuries.In our view this chart provides fairlyconvincing evidence of the logical link between funding c
20、osts and trading liquidity.We also believe that systemic risk impairs trading liquidity because it causes dealers to fear“macro trading flows.”That is,flows that are characterized by highly correlated sellingacross all orders(in contrast to idiosyncratic flow orders).For example,in August of 2011,wh
21、en credit markets are generally slow due to summer vacation schedules(and especiallyin Europe),many market makers were somewhat alarmed by the fact that European bankswere suddenly looking for bids on large blocks of bonds.Coming as it did on the back ofthe re-escalation of Euro sovereign fears and
22、the much-discussed collapse of dollar fundingfor European banks,it was natural to worry that even larger blocks of bonds were still tocome.We conjecture that risk of even greater amounts of“forced selling”is what causedmarket liquidity to dry up.We would describe this as“highly correlated flow risk.
23、”That is,it is reasonably feasible forthe dealer community to intermediate large gross flows when roughly half of these ordersare“buys”and the other half are“sells.”But when the entire market is trying to move riskin the same direction which is typically the case in face of a rapid escalation of sys
24、temicfunding concerns such risks obviously increase the riskiness and difficulty of providingmarket liquidity.It stands to reason that trading transaction costs would rise as a result.Goldman Sachs Global Economics,Commodities and Strategy Research,Basispoints,Percent,4,November 9,2012Exhibit 3:Roun
25、d-trip trading costs are high when macro volatility is high,8.57.56.55.54.53.52.51.5,Round-trip tradingcosts(RHS)Macro volatilitymeasure(RHS),3.5%3.0%2.5%2.0%1.5%1.0%0.5%0.0%,5-Jul-09,5-Jul-10,5-Jul-11,5-Jul-12,Source:Goldman Sachs Credit Strategy,TRACE.Exhibit 3 provides some evidence on the relati
26、onship between“macro trading flows”andtrading liquidity.We dont measure macro trading flows directly,but rather assume(without evidence)that macro trading flows are highly correlated with macro volatility.Tomeasure the latter,we compute the average daily stock return for the S&P 500 and use thisas a
27、 proxy for the first“macro factor”in asset markets.We then compute the volatility ofthis index using the 20-day moving standard deviation.The result is plotted in Exhibit 3,and confirms that market liquidity tends to deteriorate when macro volatility jumps.Of course,this effect is hard to disentangl
28、e from the effect of spread levels shown inExhibit 2.But there is some evidence of independent effects.A simple regression of RTTCon both bank credit spreads and macro volatility(all variables in 12-week changes)yieldson r-squared of 0.77.Both variables are statistically significant,but as Exhibits
29、2 and 3already suggest,the cost of term funding for banks enters more robustly.We conclude by noting that we have not yet introduced a role for regulation.We do notdismiss the impact that the Volcker rule or Basel-3 might have(or might yet have,since therules are still incomplete).Shorter holding pe
30、riods for security inventories and highercapital charges on certain types of inventories(and their hedges)will clearly increase thecost of supply market liquidity,whatever offsetting benefits they may offer.But against this“trend”in trading liquidity there is clearly a“cycle,”and we think the near-t
31、erm prospectsfor a cyclical improvement in trading liquidity remain positive.Charlie HimmelbergGoldman Sachs Global Economics,Commodities and Strategy Research,5,November 9,2012,Our views across credit,Credit fundamentals.Aggregate credit metrics for North American corporations havelargely reverted
32、to pre-crisis strengths,greatly outperforming the broader economy.Overthe past several quarters,both margins and leverage ratios have begun to deteriorate.Butthey are still at very good levels.In Europe,corporations continue to lag their NorthAmerican counterparts,and the pace of credit deterioratio
33、n as measured by aggregatedowngrade measures even appears to have accelerated.,Defaults.Our forecast envisions a HY default rate of 2.6%for 2012.We expect most ofthese defaults to materialize in the CCC bucket.While credit metrics for BB-rated firms havelargely reverted to pre-crisis strengths,lower
34、-rated firms,particularly in the CCC bucket,are still struggling to deleverage.On a longer horizon,our default and downgrade viewremains relatively benign.We estimate the five-year cumulative loss rate for BB-and B-rated issuers will reach 3.0%and 6.1%,respectively.These are significantly below hist
35、oricalaverages.For CCC-rated issuers,we forecast a five-year cumulative loss rate of 32%,whichis still better than the peak of the 2001/2002 recession.,Investment strategy.We favor the United States over Europe reflecting the difference infundamentals.In the United States we have a tactical preferen
36、ce for Financials over non-Financials,whereas this is a much closer call in Europe.Across ratings we continue toprefer BB-and B-rated credit in both Europe and the United States.As we discussedrecently,the high end of the HY market combines attractive valuation(at least in spreadterms)and good funda
37、mentals,which makes it the most obvious beneficiary of“search foryield”motives.,Goldman Sachs Global Economics,Commodities and Strategy Research,6,November 9,2012Weekly Picks and Pans updateExhibit 4:Investment-Grade Picks-n-PansThis list highlights our analysts favorite and least favorite bonds per
38、 coverage group(for more detail see“Top Picks and Pans”,November 8,2012).This is not intended to be a model portfolio.Some bonds may differ from rated benchmark securities.,Erin Blum,Picks212-855-7718,Bond,Pans,Bond,Healthcare REITs(Neutral),Health Care REIT Inc.,5.250%01/22,HCP,Inc.Healthcare Realt
39、y Trust,5.375%02/215.750%01/21,Gregory Chwatko,212-902-0673,Consum er Staples(Neutral)Retail(Cautious),Pernod RicardMacysWalgreen Co.,5.750%04/213.875%01/223.100%09/22,KelloggYum!Brands,Inc.KrogerSafew ay,4.000%12/203.875%11/206.150%01/203.950%08/20,Jason Gilbert,212-902-3585,Energy,Pioneer Natural
40、Resources,7.500%01/20,Valero Energy,9.375%03/19,(Neutral),Brian Jacoby,212-902-3258,Aerospace&Defense(Cautious)Autom obiles&Suppliers(Neutral)Capital Goods&Diversified Industrials(Neutral),Textron Inc.BorgWarner Inc.Ford Motor CreditUnited Technologies Corp.Deere&Co.,5.950%09/214.625%09/203.000%06/1
41、73.100%06/222.600%06/22,Northrop Grum m anRaytheon Com panyJohnson ControlsThe ADT CorporationThe ADT Corporation,3.500%03/213.125%10/203.750%12/213.500%07/224.875%07/42,Honeyw ell International,4.250%03/21,Railroads(Neutral),CSX Corp.Canadian Pacific Railw ay,4.250%06/214.500%01/22,Canadian Nationa
42、l Railw ay Co.Norfolk Southern Corporation,6.375%11/375.900%06/19,Norfolk Southern Corporation,3.000%04/22,Raymond Leung,212-357-5764,Utilities&Pow er(Neutral),Allegheny Energy Supply Co.CMS Energy,5.750%10/196.250%02/20,Duke Energy CorpConsolidated Edison,3.050%08/224.200%03/42,FirstEnergy Corp.,7.
43、375%11/31,Amanda Lynam,212-902-9238,Healthcare(Neutral),Boston ScientificGilead Sciences Inc.,6.000%01/204.400%12/21,Eli LillyMedtronic,Inc.,5.200%03/173.125%02/22,Roche,6.000%03/19,Insurance(Neutral),CNA Financial Corp.Lincoln NationalXL Group,5.750%08/214.200%03/225.750%10/21,Allstate Corp.Genw or
44、th Financial,Inc.MetLife,7.450%05/197.625%09/213.048%12/22,Scott Marchakitus,212-902-9760,Telecom&Cable(Attractive)European Telecom,Am erican Tow er Corp.CenturyLink Inc.Vodafone,4.700%03/225.800%03/224.375%03/21,Cox Com m unications,Inc.France Telecom,6.250%06/184.125%09/21,(Cautious),Carly Mattson
45、,212-902-6712,Chemicals,Eastm an Chem ical Com pany,3.600%08/22,Potash,4.875%03/20,(Neutral),Metals&Mining,N/A,Nucor Corp,4.125%09/22,(Cautious),Paper&Forest Products,Dom tar Corp.,4.400%04/22,Weyerhaeuser Co.,7.375%10/19,(Attractive),Louise Pitt,212-902-3644,US Banks(Neutral),JP Morgan,7.900%Perp,C
46、apital One Financial Corp.*Morgan Stanley,4.750%07/215.500%07/21,European Banks(Cautious),BBVAING,4.664%7.375%,10/15Perp,Credit Suisse GroupDeutsche Bank AG,4.375%08/203.250%01/16,Lloyds Banking Group PlcRoyal Bank Of Scotland,7.875%6.600%,11/20Perp,REITs(Neutral),ProLogis,Inc.SL Green Realty Corp.,
47、6.875%03/205.000%08/18,Equity Residential,4.625%12/21,Scott Wipperman,212-357-9922,Technology(Cautious)Media(Cautious),Xerox Corp.CBS Corp.New s Corp,4.500%05/213.375%03/224.500%02/21,Dell Inc.Pitney Bow es Inc.Viacom,4.625%04/216.250%03/193.125%06/22,Source:Goldman Sachs Credit Research.Goldman Sac
48、hs Global Economics,Commodities and Strategy Research,N/A,7,November 9,2012Exhibit 5:High-Yield Picks-n-PansThis list highlights our analysts favorite and least favorite bonds per coverage group(for more detail see“Top Picks and Pans”,November 8,2012).This is not intended to be a model portfolio.Som
49、e bonds may differ from rated benchmark securities.,Erin Blum,Picks212-855-7718,Bond,Pans,Bond,Healthcare Providers(Cautious)Pharm a/Med De vices(Neutral),Apria HealthcareHCAConvatecVPI Escrow Corp.,11.250%11/147.750%05/2110.500%12/186.375%10/20,Vanguard Health System sEndo Pharm aceuticals,8.000%02
50、/187.000%07/19,Kevin Coyne,212-357-9918,Consum er&Apparel,N/A,Jarden Corp.,7.500%05/17,(Neutral),Gam ing,Caesars Ent.Operating Co.,8.500%02/20,Wynn Las Vegas,7.750%08/20,(Neutral),Justine Fisher,212-357-6711,Me tals&Mining(Neutral)Shipping,Fortescue Metals GroupNovelisNavios,7.000%11/158.750%12/208.
