Chaos theory states than in complex systems, a butterfly flapping its wings in Japan can cause tornadoes in California. Whether or not that is true, a Banker in Belgium buying Greek bonds can impact the lives of factory workers in Germany. Europe continues to head down the path of making the system more complex than ever and ensuring that no bad lending, investing, or borrowing decision is ever punished.
I am still dubious that anything will be resolved. I don’t know how any variation of the plan makes Greece solvent or reduces 21% unemployment in Spain. All the variations seem to rely on the good countries putting so much money into banks and sovereigns that they cannot let them ever default. The risk will be pushed upstream until all the losses are at the sovereign level and they will eventually just print money. No other conclusion seems likely. If Germany and France want to lend money to Greece so they can make payments to banks, they can do it, but at some point it will go from a banking problem to a German/French problem. Then the printing presses will have to be turned on.
I still have some hope that the insanity will be nipped in the bud, that some country will see they are going too far and risking the futures of too many, to protect too few right now. In meantime soft commodities seem interesting as people will still have to eat.
It is a bit strange that stocks are rallying on the European solution, yet Italian and Spanish bond yields are rising. I guess that is part of the “risk on” trade, yet aren’t high yields in those countries a problem?
In the meantime at least we have earnings to save us. Well AA missed but so far the market is treating that as an isolated event. The fact that they beat on sales but missed on earnings should be getting more attention in my opinion. I would continue to look at the weak end of high yield for signs of how the real economy is doing. At a high level, the market can move in risk-on and risk-off mode, but with all the global government intervention it is hard to figure out what is really going on beneath the surface. For individual companies that are distressed, there is less that can be done to cover up the true story.
I took a look at the price changes in cash pay high yield bonds from Sept. 1 until Oct. 7. Companies whose bonds had the biggest price declines were Clearwire, Eastman Kodak, Travelport, General Maritime, Powerlong, Hidili, Minerva, Evergrande, and Wind Acquisition. Until now, I haven’t looked at these specific credits closely, but now I think it is worthwhile digging deeper for signs of what is really going on. All of those bonds dropped by at least 25 points in just over a month. Most if not all rebounded yesterday (or at least were quoted higher even if they didn’t trade), but drops of that size are not just a function of liquidity and is worth watching. If these bonds can stage significant rallies, than the economy is likely better than I believe. If these bonds remain weak, it is a good indication that real problems exist and looking at the stock market as a proxy for the economy continues to be misleading in this era of extreme government intervention.