This CDS report was written by Markit’s Gavan Nolan
The outperformance of credit vs. equity has been the prevailing market trend in recent days. The major credit indices on both sides of the Atlantic have widened consistently this week, compared to less severe movements in equity. Both asset classes lost ground today, though the retraction in credit was again more pronounced. The Markit iTraxx Europe index was trading at 123bp, over 6bp (5%) wider than yesterday’s close. The Markit HiVol and the Markit iTraxx Crossover indices reached 250bp and 750bp respectively for the first time since mid-May.
The sell-off was broad-based, with telecoms, insurers, autos and banks all underperforming. Even defensive credits such as Compass and Cadbury widened significantly. Spanish utility Iberdrola was one the few firms to tighten after it announced an equity capital raising aimed at strengthening its balance sheet.
But the day’s most prominent laggard was J Sainsbury. The UK supermarket chain reported sales figures today, and it did not disappoint. The firm said same-store sales rose 7.8% in the 13 weeks to June 13, a figure at the top end of consensus expectations and easily beating its larger rival Tesco‘s UK sales. An expansion of its value range – a departure from its premium reputation -has helped it withstand the recession and maintain market share.
But the company’s high-profile CEO Justin King is not content with the status quo. He announced ambitious expansion plans today, and it was this ambition that led to CDS spreads widening today. The firm is to raise £445 million from investors to increase its store space by 15% in the two years to March 2011. The funds will come from £225 million in new shares and £190 million in convertible bonds.
An issue of five-year debt will naturally lead to a widening in CDS spreads. But the fact that Sainsbury has a £600 million debt facility available suggests that further expansion cannot be ruled out. From a strategic perspective the plans appear to have merit. Sainsbury is under-represented in large parts of the UK and there is the potential to increase market share by expanding into these regions. Tesco is trading tighter that Sainsbury for the first time since the beginning of the year but competition between the two firms looks set to intensify.
In the US, a pessimistic outlook from FedEx added to negative sentiment. The parcel delivery company, regarded as a key barometer of economic health, said that it expects the next two quarters to be extremely difficult. The warning damaged the broader market, with rival UPS and railroad groups bearing the brunt. Other cyclical names such as Whirlpool and Macy’s widened sharply, though in truth the sell-off was comprehensive. Defensive credits Pfizer and Bristol Myers Squibb were among the few names to tighten.The banking sector was also under pressure after S&P cut its ratings on 22 US banks. The rating agency cited expectations of difficult operating conditions brought on by structural changes in the industry. One such change, increased financial regulation, became one step closer to reality today with The Obama administration announcing plans for a new regulatory system. Most of the measures appear unsurprising.
The Markit CDX IG index widened 5bp to 141bp, recovering from 145bp levels reached earlier today. Compared to credit, stock indices held up well, posting small gains. Some investors took heart from the latest consumer prices figures, which showed an increase of just 0.1% in May. Inflation concerns look to be receding, and US Treasury yields fell sharply, particularly at the long-end.