Brace for volatility, illiquidity in credit, and risks in e-commerce and EM valuations

Published on 9 October 2023

Orlando Gemes, founder, and chief investment officer at Fairwater Capital, provides his views on what to expect from the credit and equities markets this week and urges desks to prepare for upcoming volatility. He also discusses the new issue market; where we might see illiquidity in credit; Fairwater’s approach to the e-commerce sector and convertible bonds, and the ongoing turmoil in global real estate.

Transcript of interview:

Jo Gallagher: Welcome to Trader TV This Week – your insight into how your trading desk can prepare for the week ahead. I am Jo Gallagher.

Today I’m joined by Orlando Gemes at Fairwater Capital to discuss the main topics and events leading this week. Orlando, welcome to the show.

Orlando Gemes: Hi, Jo. Thanks for having me.

Jo Gallagher: Before we start, let’s take a quick look at last week’s activity and what’s coming up.

In North America, last week’s equities volumes are an average net loss for the year, but the spreads appear tight. US investment grade volumes remained elevated relative to the yearly average. And last week, US treasury yields saw some of the highest levels for more than a decade.

Liquidity in US IG also appears very good, and bid-ask spreads are tight for 2023.

This week, markets will be paying attention to data on producer prices on Wednesday, but the flagship economic front will be the US’s core inflation and initial jobless claims on Thursday.

We can also expect Q3 earnings results to kick off with heavyweight financials such as J.P. Morgan, City and BlackRock expected on Friday.

In primary equities, North America is expected to price three IPOs is this week with aggregate of more than $1.5 billion, the largest being Birkenstock Holdings, which is seeking to raise just under the one and a half billion. And if successful, it would become the third biggest IPO this year, behind ARM Holdings and KENVUE.

US axe data, which is within historical ranges, indicates dealers bids have increased by a mere 1.9% for assets in the past week, suggesting a leaning towards buying of credit going into the week ahead.

In New York and the UK, last weeks equities volumes rose week on week and climbed just above average levels for the year. Much of those volumes were spikes in sell off activity across all dark and lit venues, showing markets are concerned about weaker consumer spending.

Liquidity across stocks worsened week on week, but spreads are hovering around average levels for 2023. Last week’s Euro investment grade volumes were down compared to the highs the week before, but are still at elevated levels for the year. There were mixed data readings on Euro IG liquidity. However, it appears the cost of execution increased week on week. Yet bid-ask spreads remain narrow for the 14 week average.

In terms of economic indicators this week we will have the UK’s GDP print on Thursday and numbers on the EUs industrial production on Friday.

In primary equities, one IPO is expected to price on the Euronext Paris Exchange this week. The tech firm Planisware looks to raise $270.9 million and if listed as expected, this will mark the seventh IPO on Euronext Paris this year.

EU axe data which is within normal ranges indicates the proportion of EU dealers bids versus asks has increased by a massive 25.3%. GBP dealer bids are up by 15.3% against asks over the past week, suggesting a strong leaning towards buying versus selling of credit going into the week ahead.

Orlando, lots to cover there. How would you be advising trading desks to approach the upcoming week?

Orlando Gemes: We’ve just seen the non-timed payrolls report, which has continued to show the robust nature of the US economy and shows the complicated situation that the Federal Reserve is now facing as they consider whether to continue increasing interest rates. We’ve seen the yield curve continue to disinvert, now trading around 30 basis points, having been 108 basis points inverted. We’re seeing volatility pick up in equities, fixed income and in foreign exchange. The MOVE index that measures US Treasury volatility has increased to 140, having been as low as 100. The VIX is now trading up around 20, having been below 13 during the summer. So from the Fairwater perspective, we very much want to stay long volatility and convexity and make sure that we’re not short illiquidity premium as we go into these higher volatility markets.

Jo Gallagher: What are your expectations for the new issue market and how is Fairwater planning for that in Q4?

Orlando Gemes: So we’ve recently seen the new issue market open up for equities, credit and even for collateralized loan obligations. However, we’ve seen some large volatility. The Instacart IPO printed at $30 a share and more recently they’ve traded down around 35%. And also volumes have shrunk. In credit, we’ve seen a tightening throughout the year that has now allowed triple A’s and C’s to move from 190 at the beginning of the year down to 170 and triple B tranches traded as tight as 500. This tightening of the arbitrage has allowed the new issue market to reopen. But what we’ve seen from the new issue market has been that the market can underperform very rapidly, can get quite illiquid. As we’ve seen, volatility is going to continue to be key. Illiquidity is something to be very concerned about and we’re going to be looking for dispersion trades and how we remain long convexity into the end of the year.

Jo Gallagher: What are your concerns in the e-commerce and the home delivery space and who are going to be the losers there?

Orlando Gemes: So as I mentioned, we’ve recently had the Instacart IPO, which has drawn the market’s attention back to the sector. But we think it’s important to look at a wide range of names, including DoorDash, Ocado, Delivery Hero, and on the whole, a lot of them continue to burn cash very rapidly. The Ocado CEO was speaking to Bloomberg and gave very bullish views on the outlook for his company. But we think when you consider the volatility that has been experienced in the stock and in the convertible bonds, that there’s clear market concern about the speed of their cash flow. And this very much speaks to Fairwaters approach. We use a systematic approach to deconstruct convertible bonds into the sum of their parts. So we look at the bottom floor and the value of their call option to understand whether there is an arbitrage or a mispriced opportunity.

Jo Gallagher: It’s been a tough year in terms of valuations for real estate. How do you see that story playing out in Q4 and what’s being overlooked there?

Orlando Gemes: So we expect the real estate market to remain in turmoil in the last quarter of 2023 and to continue to be in a difficult state in 2024. We have seen anemic volumes in the direct market. We have seen the credit markets become very dislocated and illiquid, and there’s a great deal of conjecture around the valuations, particularly for commercial real estate offices and retail. We have a lot of companies with unsustainable capital structures and management who have failed to match their assets and liabilities in terms of duration.

In China, we’ve seen the ongoing issues around the major bond issuers. We see a huge oversupply in the market and ongoing issues in the quality of production. And for global investors, there are real concerns around corporate governance and transparency, particularly the issues around valuations. This has been an issue in China, but also more recently in India. And for Fairwater, what this means is that we really have to take apart capital structures and see whether we are getting the same story from the equity and credit markets. And in many cases we find that that’s not the case. So that’s the opportunity for us, the same way that there is an asymmetric payoff profile to be achieved.

Jo Gallagher: Thank you, Orlando, for your insights and thank you for watching.

This has been Trader TV This Week.