First Quarter: Soft Appetite, Focused Demand

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Our securities lending trading team kicks off the second quarter by reflecting on Q1 and looking ahead to the remainder of the year.

The global markets have had a strong run during the first quarter as both economic and market indicators continue to show promise. The rebound in corporate earnings has driven valuations higher as investors position themselves ahead of potential policy changes from the Trump administration. By mid-March the Federal Reserve took another step toward “normalcy” by raising its target for the overnight funds rate to a new range of 0.75% to 1.00%. While in Europe, the Central Bank (ECB) left interest rates unchanged as growth expectations improve and talks of a QE taper remained high on the agenda. In Asia, China’s growing pile of bad debt continues to be a source of concern and potential risk to the global financial system as the PBOC raised short-term policy rates for the third time in three months. Meanwhile in Japan, the country’s economic recovery is continuing at a moderate pace and the Bank of Japan (BoJ) decided to maintain the -0.1% interest rate on current accounts.

In terms of securities lending activity we appear to be at a cyclical low particularly in terms of “hard to borrow activity.” Much of this can be attributed to market positioning by investors, but there also could be some hesitancy in expressing anything but bullish sentiment after a tough 2016. That said, we still believe that the signs are there for increased securities lending activity as we look a little further ahead and themes begin to unfold.

In the summary that follows, each of our Trading desks shares their viewpoints on Q1 and what to expect from the securities lending market this year. For an in depth review on the current landscape, click over to “Same Story, Different Ending,” Keith Haberlin’s take on 2017 to date and what lies ahead.

United States

  • Directional demand in the US remains concentrated in a few top names while some long term sectors have fallen out of favor. Top earning stocks across the industry include familiar names such as Under Armour, Inc. (UAA), Tesla Inc. (TSLA), Insys Therapeutics, Inc. (INSY) and Weight Watchers International, Inc. (WTW).
  • Short interest in biotech names is near – or at, in some cases – 12-month lows. Demand for some shares that had seen strong long-term demand has fallen off as a result. We believe the market is taking a view that these stocks are properly priced with regard to growth expectations and valuation.
  • Looking ahead, we anticipate continued crowding in specific short names, with the focus remaining on the names currently in demand. We believe the oil and gas sector will pick up steam as we head into the second quarter as the supply glut and falling crude prices remain problematic for companies in the sector.
  • ETFs are in the spotlight as funds look to hedge positions. This is thought to be relatively less expensive than the costs of traditional hedging tools such as futures, options, and forwards.
  • Interest has picked up for many Chinese ADRs across different sectors including 500.om Ltd (WBAI), Yirendai Ltd. (YRD), JinkoSolar Holding Company Limited (JKS) and Weibo Corp (WB). According to Bloomberg, the Hang Seng Index and Shanghai Composite Index both fell the most this month, while a gauge of Chinese stocks traded in Hong Kong had the steepest drop since mid-January. Poor consumer inflation numbers appear to be to blame for the declines.

Europe

  • European demand has been directional and focused on specific names, in contrast to the sector-focused short plays we historically seen.
  • The rebound in commodity prices, particularly in oil, has reduced short activity for oil exploration companies. Similar to the US, we expect this could change in Q2.
  • Corporate action activity is thriving, mainly thanks to rights issues from companies looking to raise capital to solve for cash flow problems or banking firms that need to meet ECB capital requirements.
  • There have been a couple of green shoots of M&A activity, specifically in the new home building sector and in the energy service sector.

Asia

  • Japanese lending returns continue to improve as a result of strong specials activity. Demand has been driven by an increase in corporate deals, M&A, share offerings and a rise in corporate governance scandals that have boosted demand.
  • Despite some bright spots, the demand environment is likely to remain challenging in the first half of 2017. This is driven by reduced short interest in Hong Kong and Korea, plus an uncertain geopolitical environment.
  • The demand environment in both Hong Kong and Korea remains challenging due to significantly reduced hedge fund demand and a decrease in specials activity. There has been a general long bias as global markets rally.
  • APAC Quant fund demand is growing quickly, with research data showing 79% of investors allocating to the space. Growth in the Quant fund space means breadth, rather than depth, of lending supply is becoming increasingly important.