To be sure, the stock market is rich in irony. Now the word âironyâ is derived from ancient Greek meaning an incongruity between the actual result of a sequence of events and the normal or expected result. And isnât it ironic that over the past few weeks the worldâs focus has shifted from Greece to Italy as Italyâs sovereign debt traveled over the 7% yield threshold last week. While numerous pundits offered reasons for the surge, I tried to explain the near-term issue on CNBC last Wednesday morning. The sound bite went something like this:
In the short run, I think the real problem is in the CDS market. There is a crash going on in the Italian CDS market and if you donât fix that, Italyâs sovereign debt is going above 7%. To wit, If you are a buyer of Italian sovereign debt and want to hedge it against a possible default, the way you do that is to buy Italian collateralized debt securities (CDS). However, if investors perceive the guarantor of that CDS might not honor the guarantee, investors wonât buy the CDS, causing a crash in the CDS market. Accordingly, if you canât hedge your âlongâ Italian sovereign debt, you are just as likely to sell it and that drives yields higher. Itâs a vicious circle, which is why on CNBC I said the Italian CDS market needs to be âfixedâ yesterday. Yet, my counsel fell on deaf ears, overshadowed by the LCH Clearnetâs raising of margin requirements on Italian debt, which amplified the CDS situation, both of which sent yields on the Italian debt soaring. The margin change should also affect spreads against other sovereign debt like Spain and France. No wonder various markets crumbled as they contemplated a domino effect that would likely wash onto our shores; and, those events caused Wednesdayâs Dow Dive of some 389 points. The carpet bombing decline qualified as a 90% Downside Day with 96% of total volume coming on the downside, while downside points exceeded 90% of the total points traded.
Of course that caused my email box to light up with worried inquiries. Yet while itâs always alarming to see market meltdowns, by my work all we experienced was another consolidation. That said, if my pivot point of 1217 is violated, it would be a warning sign. Therefore, as stated in Thursdayâs verbal strategy comments, âBy my work all that occurred in Wednesdayâs Wilt was another consolidation day rather than the start of a new âlegâ to the downside.â Moreover, there were a number of stocks that held up really well in Wednesdayâs bombing: HCA (HCA/$26.53/Outperform); LINN Energy (LINE/$37.00/Strong Buy); Williams Company (WMB/$31.34/Outperform); SuccessFactors (SFSF/$28.10/Strong Buy); and I actually think Tangoe (TNGO/$14.40/Strong Buy) would have been up sharply on its âblowoutâ earnings report if the stock market hadnât stumbled. Verily, Tangoe beat on all metrics with revenues up 59%, earnings better than expected, EBITDA improving an eye-popping 83%, while free cash flow was $1.6 million versus the $948,000 estimates.
The call for this week: While in the short run, I think Italyâs yield yelp was exaggerated by issues in the CDS market, longer term it is all about a single currency, the Euro, which has misallocated capital, making countries like Greece uncompetitive. The key to a more sustainable European situation will come if/when the bond spreads between Germany and other European countries begin to tighten. As for our equity markets, I think we either made a short-term trading top late last week, or will make one early this week, that will lead to attempts to sell stocks off. However, I suspect such attempts will prove shallow and short with support appearing in the 1220 â 1240 zone.
Copyright © Raymond James
