Market update 5 4 10

 

Looking for a safe harbor

 

The markets are seeing a flight to safety today.  There is a great deal of concern that the problems in Greece will spread to other areas of the Euro zone and it is spooking the markets in a material way.  The Dow Jones Industrials are off 242 points to trade at 10,909.  They’ve traded below 11,000 for the better part of the day.  Every stock index in Europe is in negative territory for the day, Treasuries have been in full rally mode from the open, and the 10 year Treasury is currently up 19/32’s to trade with a 3.60% yield. 

 

Stocks

 

Below is a list of the major equity indices around the world and how they’ve performed today.  There is only one major stock index on the planet that is up today…the Nikkei 225…maybe they didn’t watch the news…or maybe they are a bunch of contrarians, who knows.  At any rate, the entire world seems to be concerned over the problems in Europe.  Money is leaving risky assets and moving toward safer harbors.

 

When I see every stock index on the planet down at the same time it makes me wonder if diversification is worth the effort.  It seems like it would just be easier to lose money in one language rather than a bunch of different ones. 

 

Oh the irony

 

Everyone has a passing familiarity with Credit Default Swaps at this point in history.  As a quick and dirty refresher you just need to know that the CDS spread is the amount (in basis points) that you have to pay to get insurance against default on a bond.  With that bit of housekeeping aside let’s look at some real world example.

 

These spreads are all relative so let’s look at the cost of insuring a good bond first.  If you want to buy default insurance against a AA rated bond issued by Japan you’d be looking at a cost of 12 basis points.  Have concerns over the debt of Great Britain then you need to pony up 39 basis points up front for insurance.  Worried about Texas debt?  41 basis points.

 

If you own Greek government debt and you want to buy insurance against loss for a year it will cost you 999.57 basis points up front.  What you get for this is your entire principal amount back if Greece defaults on the issue.  So you pay up front, and if it all goes south you put a bond worth maybe 15 cents to the insurer and they give you par.  Without even looking at the actual numbers for settlement date we can clearly see that Greek debt is considered more risky than debt from the State of Texas.  After all it costs almost 1,000 bps to insure against default on Greek debt vs. only 41 bps on Texas debt.  So far so good.

 

This next bit I find alarming.  Credit Default Swap spreads on debt from the Islamic Republic of Pakistan are priced at 744 basis points.  Insurance on Pakistani bonds is 247 bps CHEAPER than that on the debt of Greece.

 

As I ponder this arrangement I envision Pakistan in my mind.  The image that comes to mind is a dirty, third world, desperately poor country with a serious terrorist problem, an unstable government, angry neighbors, and a very loose hold on its nuclear arsenal.  We are CURRENTLY BOMBING places in this country, the most wanted terrorist in the entire world is rumored to live there, and the latest news suggests that people in Pakistan are involved in the recent attempt to car bomb Times Square in New York City.  The country can’t control vast swaths of its own country (this one is a push since we can’t either), instead they simply call those areas “lawless tribal lands” and let the terrorists have a de facto home country.  The market currently considers this country as being in better shape to repay its debt than is Greece.  I find that remarkable. 

 

I’m gonna go buy a Gyro sandwich and some baklava tonight…while I still can. 

 

That’s all the news to report this afternoon.

 

If you have any questions or if there is anything I can be doing for you just let me know.

 

Steve Scaramastro, SVP

800-311-0707