Trade tariffs, May sell-off seen as big drawbacks in sales of structured notes this year

By Emma Trincal

New York, June 5 – The stock market sell-off continued unabated last week as trade jitters made investors increasingly nervous.

In the shortened week following Memorial Day, the S&P 500 index dropped 2.68% and the Dow Jones industrial average had its worst week of the year, down 3%.

It did not help structured notes in general, as it has been the case so far this year. The most recent figures compiled by Prospect News showed a 35% decline in structured products issuance year to date from last year.

“It’s not good and this time you can’t really say: it’s only because it’s the beginning of the year. We’re almost halfway through the year. Trailing figures I’m sure look better but it’s still not great,” a sellsider said.

Volume in the trailing 12-month period showed a 16% decline from the previous trailing.

Too much noise

For this sellsider, finding a reason behind this year’s decline was a complex affair.

“Maybe it’s the uncertainty in the market but then why? It’s when the market is uncertain that structured products are supposed to help. So, it’s really hard to say,” the sellsider said.

“Uncertainty is a double-edged sword. You can have two completely opposite reactions from investors.

“If they’re rational, they’ll think it’s time for them to buffer their exposure or use leverage to self-buffer.”

He explained the term “self-buffering” as follow: leverage allows for getting a fraction of one’s notional invested in the market. For instance, with three times leverage, an investor or adviser may allocate 33% of his exposure to equities and use the rest with safe assets.

“The other reaction is the non-rational one, and we see a lot of it right now. People may say: ‘I don’t have any view; I’m not even mildly bullish. I absolutely have no idea where the market is heading right now. I have no interest in investing in anything.’

“I think that’s what many investors are doing right now. And it hurts structured notes but not only that. It hurts the overall market too.

“May has not been good for anyone.”

Up and down

The year so far has shown two noticeable trends in the market. Up until May 1, the S&P 500 rallied 20.7%. The benchmark hit an all-time high on May 1 at 2,954.13. Since then, however, stock prices have been under pressure with the index losing 4.75%.

Some sellsiders when comparing this year’s issuance flow with last year point to the fact that the sell-off began early on last year and quickly “got out of the way,” until October while the reverse is happening this year.

Freshly shaken by the Christmas Eve short-lived bear market, investors did not immediately trust the big rally early on this year. Now the escalating trade war between the U.S. and China is increasingly driving price action in a negative direction, giving investors little motivation to buy structured notes.

“At the very beginning of May, the market started to head down,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management, looking at last month.

“By the middle of the month, it started to come back but then it failed to break out. The month wasn’t pretty so I think some of the buyers of structured notes decided that they wanted to hold on buying.”

Uncertainty

“A lot of what’s moving the market is political. On the negative side, you have a president who calls himself Tariff Man. His tweets are constantly rocking the market. This has been the source of this month’s sell-off,” the sellsider said.

“He’s supposed to be pro-business. And look at what’s going on.

“Nobody wants these tariffs. The only people who want them are uninformed people who think America First is the way to go without realizing that tariffs on trade is hurting the global economy including the U.S.”

Other political factors are directly impacting the market as well.

Earlier this week, the government’s initiative to enforce a regulatory scrutiny of large technology firms – the so-called “FANG” – pushed the Nasdaq 100 Composite lower.

On the other hand, talks about a Federal Reserve’s rate cut had the opposite effect prompting a rally since Tuesday.

Volatile volatility

The CBOE VIX index, which measures implied volatility of the S&P 500 index, has been volatile itself, surging to over 20 in the middle of the month to less than 15 two weeks ago. It then proceeded to climb again settling around 19 in the beginning of June before falling once more to 16.50 on Wednesday.

“Sometimes people think that the slowdown in issuance is because volatility is not high enough,” said the sellsider.

“Yes, high volatility helps pricing. But right now, I’m more worried about high volatility. It’s not high by historical standards. But it’s unstable. We have some volatility of volatility and I wish it would just go back to normal.

“Again, a lot of this is driven by the trade war headlines. It’s not helpful for investors.

“What’s going on in our industry right now is similar to what’s happening in the overall market. People are not putting any new money to work. They’re just sitting on the sidelines.”

Noteworthy deals

Morgan Stanley priced a $34.25 million deal on the behalf of Citigroup Global Markets Holdings Inc.

It was a one-year issue of capped gears linked to the S&P 500 index with three times the index return subject to a 12.531% cap on the upside and full exposure to any losses.

“It’s a Merrill-type of deal but the agent is UBS,” the sellsider said.

He was referring to the Accelerated Return Notes popularized by the BofA Merrill Lynch distribution channel. Those best-selling trades are characterized by a short duration, a high leverage multiple and no downside protection.

Merrill Lynch priced its own block leveraged trade with exposure to the small-cap benchmark.

It was Barclays Bank plc’s $30.45 million of 14-month Accelerated Return Notes due July 31, 2020 linked to the Russell 2000 index.

The upside leverage multiple is also three. The cap is 14.43%, and investors are fully exposed to losses.

Worst-of continued to be popular and mostly on equity indexes.

“Not a surprise. It’s always been easier to have a view on the market than on two or three single stocks,” the sellsider said.

One notable exception was Credit Suisse AG, London Branch’s $13.92 million of autocallable contingent income securities due Sept. 3, 2021 linked to Apple Inc. and Amazon.com, Inc.

The quarterly contingent coupon is 11% per year based on a coupon barrier of 65%.

The notes will be automatically called on a quarterly basis if the worst-of closes at or above its initial share price. The barrier at maturity is 65% as well.

Morgan Stanley Smith Barney LLC is the distributor.

“What’s going on in our industry right now is similar to what’s happening in the overall market. People are not putting any new money to work. They’re just sitting on the sidelines.” – A sellsider

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