Volume gets lighter as summer kicks off, tax deadline looms; volatility still low

By Emma Trincal

New York, July 15 – Issuance volume was light in the first full week of July, which was part seasonal, part the result of deal filing delays due to the Independence Day weekend.

However, the previous week of June 28 overlapping June and July saw a healthier tally of $636 million in 304 deals, according to data compiled by Prospect News.

Last week’s figures amounted to $50 million in 68 deals, a preliminary number which will be upgraded.

The tax deadline postponed this year to July 15 may have also put advisers on hold last week.

Finally, the overall market is having a love affair with technology stocks, which has led many to take long positions in a roaring bull market directly rather than in derivatives, at least for now.

During the busier week of June 28, leveraged deals picked up a bit, amounting to 25% of the week’s notional volume while autocallables remained the top structure with a 52% share.

Volatility

So far, the worst month of the year has been May with $4.67 billion in 1,641 deals. The best one is March with a tally of $7.03 billion in 1,905 offerings, a record in issuance volume, according to the data.

“March was the best month ever. I hear it across the board from all the issuers we deal with and we deal with a lot of issuers,” a distributor said.

“Things have quieted down since April as volatility dropped.”

The data showed that sales in June picked up a little bit since April with $5.98 billion versus $4.72 billion in April.

But the increase is modest.

“When the market hit its low on March 23, volatility was very, very high. In April, conditions were still decent.

But issuers started to struggle with their positions, having a hard time holding levels. Many issued at the low end of the range,” he said.

“And now we’re taking July off.”

Mega tech

The S&P 500 index rose 1.76% last week driven by the tech-heavy Nasdaq, which scored another record high.

Some analysts see a danger in this bid on technology as it has been the fuel for the recovery rally. Since its low in March, nearly four months ago, the S&P has jumped more than 45% through Friday despite rising Covid-19 cases in several states.

Most of those tech stocks, including Apple, Amazon, Microsoft, and Alphabet have over $1.5 trillion in market capitalization.

The market is therefore dependent on a small number of giant stocks, as noted by Patrick J. O'Hare, analyst at research firm Briefing.com.

“It's a new day full of new news, but there's only one storyline that seems to be registering with the stock market.

“It's not the trend in coronavirus case counts. It's not the trend in presidential election polls. It's not the trend in diplomatic dealings. It's certainly not the trend in earnings growth...What is the trend that matters? It's the trend in the mega‐cap stocks,” said O'Hare in a recent note.

“That seems to be the only thing that matters, because that's where it seems as if all the money is flowing [...] and because that's the trend that has been dictating the performance of the major indices and related index funds where a lot of investor money is concentrated.”

Narrow, fragile rally

Lance Roberts, chief investment strategist at Clarity Financial, agreed and found the trend concerning.

“A healthy rally is one with broad participation. The current rally is very narrow, historically dependent on less than 2% of the S&P 500 member stocks. Such means the overall performance of the S&P 500 is not representative of the market as a whole. It also means the index performance hinges on a very small group of stocks.”

The rally is also dependent on other factors, which contribute to its fragility. Sources pointed to hopes for a vaccine and a continuation of the fiscal stimulus as two important conditions for the rally to have legs.

“I don’t want to predict the market, but I think volatility is going to pick up in August going into the elections,” the distributor said.

“It will be good for distribution. Terms will improve.”

Low rates

Volume for the year through July 10 is $37.248 billion, a 52.7% jump from last year’s $24.39 billion.

Autocallables represent more than 50% of total sales versus 27.3% for leverage.

But most of the autocalls are linked to equity indexes as equity indexes make for 70% of total issuance volume versus 20% for single stocks and baskets of stocks.

“Rates having fallen so dramatically argues for income-notes and equity-linked notes to supplement income because it’s difficult to find income elsewhere.

“We are not seeing any yield in fixed income.

“I’m expecting range accrual and other income-oriented notes to gain in popularity.”

Leverage

Leveraged notes with no downside protection have increased in volume this year accounting for $3.44 billion from $2.735 billion, a 26% rise from last year.

In comparison, leveraged notes with barriers or buffers have seen their notional sales stagnate at $6.74 billion compared to $6.25 billion last year.

The main problem has been the pricing of the protection in a highly volatile market.

“After this V-shape bounce in the market –we’re almost back to the high of February – buffered notes are really a good idea,” said the distributor.

“They’re hard to price. That doesn’t mean they’re not a good idea...especially if we see that the average equity return is becoming much lower. The cap in that case becomes an attractive option.”

Covid stocks

Meanwhile volatility remains subdued, which may explain the appeal of highly volatile names or relatively more volatile sectors.

Bets on vaccines and drugs for Covid-19 have caught investors’ attention.

“It’s not just technology. Biotech is very popular as well,” the distributor said.

“We’ve seen a few deals on XBI,” he said referring to the ticker of the SPDR S&P Biotech exchange-traded fund, which is listed on the NYSE Arca.

Almost none of those notes are linked to a single biotech stock, at least not for now.

Roaring Tesla

In the technology sector however, some notes linked to a single and highly volatile stock allow for sizeable deals, which can provide the necessary premium to price high and guaranteed coupons through reverse convertible-types of structures.

An example was UBS AG, London Branch’s $10 million of one-year 14.8% buffered income autocallable securities linked to Tesla, Inc.

Interest is payable quarterly, and the notes are automatically called on the quarterly determination date if the underlying is at or above its initial price. Tesla has an implied volatility of 126.5%, compared to 24% for the S&P 500 index. Therefore, the issuer had no difficulty pricing a 50% barrier at maturity. Tesla is up 260% for the year.

UBS Securities LLC is the agent and Morgan Stanley Wealth Management is the dealer.

“Tech stocks are still taking us by storm. How long are they going to stay the Masters of the Universe?” said Steve Doucette, financial adviser at Proctor Financial.

“Look at the crazy rise of Tesla. If you short it, you are an idiot. But how do you buy it? The P/E is through the roof.” He was not commenting on the deal specifically.

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