Home > Uncategorized > 2012/01/24: (Yet) To Be, or Not To Be (Discounted)? That is the Question

2012/01/24: (Yet) To Be, or Not To Be (Discounted)? That is the Question

© 2012 ROHR International, Inc. All International rights reserved.

The good ship Greek Debt Negotiation has seemed to suffer the same fate as the Costa Concordia (with due respect for the latter being a human as well as a financial tragedy.) Both ran close to the shoals of disaster. The Concordia in the form of an actual shoal, and the debt negotiations in the even murkier shallows of financial canard. The difference is that the Concordia should reasonably have had a chance to avoid its fate through either high-tech instrumentation warnings or more conservative navigation by its captain. The Greek debt negotiation was already effectively aground before it started, after very early technical indications the country was drowning in more debt than it could possibly service were widely ignored.

More on that intractable situation below. The real question is how the equity markets are gliding along so well near the top of their recent rally in the wake of the indication at the top of this week those negotiations were truly failing. Is it possible that a Greek debt default on (or into) its major March 20th €14.4 billion bond maturation is already discounted? Is it possible this is something the equity markets can simply ignore? Or is it more so that this is yet to be discounted at some point in the future? Drawing the full implications of all that is nothing less than disturbing and fascinating.

First of all, for the edification of anyone who happens to have been in a coma for the past several months, there is the now crystallized reason why that negotiation is intractable. Until this weekend into Monday, the negotiations had danced gingerly around the extent of ‘haircuts’ Private Sector Involvement (PSI) would be willing to accommodate. While they started off quite a bit lower prior to even higher percentage write-downs being requested by the powers that be, the PSI position is that they refuse to take more than a 65%-70% reduction on the face value of their Greek debt holdings.

That runs contrary to the demands of the ‘public’ holders of Greek debt, such as the European Central Bank (ECB), European Financial Stability Facility (EFSF), and other public holders. Due to their position defending the public trust and purse, they partially relish and are partially stuck with the idea that the full face value of their 40% holding of the Greek debt under review for rescheduling is sacrosanct. Well, that combination really doesn’t leave enough forgiveness of Greek indebtedness to lower interest rates to a level that will allow the small nation to grow its way out of its Brobdingnagian debt load.

The PSI position of no more than a 65%-70% reduction in the value of its holdings seems pretty reasonable. Even allowing some sympathy for officialdom that is saddled with no ability to compromise even if they thought it might work out, what did they expect? Let’s leave aside for a moment that this entire exercise is substantially an extension of the authorities’ disdain for the Credit Default Swap (CDS) market, which we (among many others) warned was a mistake from the beginning. Telling someone you want them to lose more than two-thirds of the value of a bond on a ‘voluntary’ basis because that would not represent a ‘default’ (or “credit event” as it is officially known) is insane.

There is a well-founded perception that “the extreme tests the mean.” Making extreme assumptions can test the veracity or specious nature of a particular assertion. How much more forgiveness would the ‘public’ holders expect to still be voluntary, and thereby not be designated a credit event that would trigger the payout on the Greek debt CDS? 80%? 85%? 90%? Here’s a thought. Let’s have the PSI agree to 100% forgiveness of principal on those Greek bonds!

Evidently if this is voluntary, the vaporization of every scintilla of value is still not a default. Of course that is silly on the face of it, and illustrates how the public holders’ position has officially moved from the ridiculous to the fully sublime. After the initial mistakes of allowing Greece into the euro in the first place, and then ignoring its rampant borrowing spree just because the banks were happy to make AAA loans, there are only two possible conclusions to this affair.

The first is for the rest of Europe (and given the state of the rest of the southern sisters, that means Germany, France and other successful northern tier states) to pony up and cover the loss.The second is for Greece to default, and very possibly still foment more than a bit of a crisis among the banks holding its debt. Whatever may transpire, the recent actions by the ECB and others to bolster the banks will still need to be accelerated if the public purse of the successful northern tier doesn’t repair the breach in the hull of the good ship Greek Debt Negotiation.

As Europe is already headed into a recession, the outcome of that situation may be a reasonably influential determinant of whether it is a mild one or a deeper recession. In any event, given the export market that Europe is for the balance of the world (and especially China and the US), the upbeat economic sentiment which is buoying the equities right now seems a bit of mystery; even in light of recent better-than-expected economic data. The dilemma is that all of that data is either current or even more so “rearview mirror” data from previous months.

The equity market seems to not want to discount a more downbeat outlook based upon the European contraction and its potential depth due to what seems to be a looming default by Greece. Is it possible that growth in the US and a soft landing in Chinawill be strong enough that a truly disruptive event in Europe will not have that much of an impact?Or is it yet to be discounted, much like the failed US Debt negotiations last summer, only once the final impact is nearer? And that seems to be the question.

General Market Observations

It is certainly possible that this crowded event week is predisposing equities to maintain the bid in the short term. There are several key anticipatory factors which might be assisting them early this week, while weighing on the primary government bond markets and US dollar. The first of those is this evening’s State of the Union address by President Obama. Who really wants to be short in front of a guaranteed dose of “further economic stimulus” and “housing market relief” happy talk?

And we can anticipate a whole lot of that, given the this will undoubtedly be the formal kickoff speech for the US 2012 general election campaign. Then there will be tomorrow’s opening of the World Economic Forum in Davos, Switzerland. Once again expect some happy talk from opening keynote speaker, Chancellor Merkel of Germany. There will undoubtedly be a significant reference to how well everyone is communicating and cooperating, regardless of the real world lack of substance on almost all sides since the crisis first erupted in May of 2010. And then it’s on to tomorrow’s FOMC rate decision and statement that is followed by Chairman Bernanke’s press conference. Anyone want to bet against there being significant reference to “things improving, even if more slowly than we would like”?

Along with further scheduled and ad hoc pronouncements out of Davos suggesting solutions to the European problem in particular and global growth in general, there are more governmental and ministerial meetings right through the end of the week. These also hold the potential to provide further upbeat sentiment that may well assist the equities in holding up for now. The return to more stressful influences will likely need to wait until next week’s significant Italian bond auctions and an EU Summit that will highlight the degree to which all of the sound and fury this week have failed to accomplish anything if nothing substantive is agreed.

That said, equities may anticipate the positive or negative outcome of this week’s extensive machinations. That would be most clearly signaled either way by a March S&P 500 future push above key 1,310-15 trend resistance, or a failure at least back below the 1,300 area; even if the ultimate burden of proof on the bears is to foment a failure back below the 1,280-75 area. In either event, the market would likely proceed another $30 higher or lower if one of those key parameters violated. Of course, that would be with due influence back into the other asset classes.


Of note is the macro-technical restoration of classical counterpoint on the equities strength weighing on primary government bond markets and the US dollar. March T-note finally dropped below the 130-16 area, yet along with the other primary bond markets managed to hold lower support into 129-24. March Gilt future similarly violated short-term support in the 116.50 area, and interim 115.50 support prior to holding important lower 115.00-114.85 support. March Bund future failed key short-term support at 139.30-.20 and interim 138.30-.00 support, yet has still managed to hold with only minor slippage below ultimate extended support in the 137.50-.30 area.

The point is that after the equities, govvies and US dollar all rallied together until early last week, classical intermarket tendencies have been restored. And further, it is all recalibrated to the major government bond markets being down at significant supports together. Yet, there is a final note on odd intermarket indications that bring the further potential strength of equities into question: if there is so much economic strength signaled by equity markets that indicate it is coming and will continue to feed off it, why are the short money forwards so very resilient? It all seems to be not much more than a curve steepening reaction to the equities strength so far.

The other very interesting development is that in spite of seemingly more constructive indications out of Europe, the euro is stalling once again into key resistance. Even though the US Dollar Index weakened off below its near-term .8050-30 support, it has managed to hold well into much more critical support in the .7950 area major channel UP Break. It is also the case EUR/USD rallied back above its major 1.2860 January 2011 low, yet has stalled so far on the current rally into more formidable resistance in the mid-upper 1.3000 area. That said, it did exhibit a 1.2925 UP Break out of its overall down channel (from the major October 1.4248 high), which will tend to reinforce the critical nature of the 1.2860 level once again as a natural Tolerance.

Thanks for your interest.

  1. usikpa
    January 24, 2012 at 3:42 PM

    Well, If market is a patient, politicians are doctors with prescriptions of liquidity shots, then this market is ‘high,’ having lost its discounting ability

    • January 25, 2012 at 7:11 AM

      Thanks for that… good metaphor.

      And maybe at least temporarily the case (continuing the medical reference doctor.) Yet the reaction to last year’s US July debt negotiation failure demonstrated what happens when reality bites, and the side effects from previous blithe ignorance set in.

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