Saturday, January 28, 2012

Today's Major Market Move: Greek Stock Market Up 16% in January

Greek equity investors appear to have a high level of confidence that there will be a positive outcome from the current debt negotiations going on between Greek authorities and investors in Greek bonds. As the negotiations have continued through the current month of January, investors have bid up the FTSE/ASE 20 Index 16% making it the third best performing benchmark equity index. Here's the top 10:

Click here to go to the live table.
Here are the details of the last status report of the negotiations, courtesy of Fox News:
Under the tentative agreement, announced Saturday, investors holding €206 billion in Greek bonds, or about $272 billion, would exchange them for bonds with half the face value. The replacement bonds would have a longer maturity and pay a lower interest rate.

The deal would reduce Greece's annual interest expense from about €10 billion to about €4 billion. When the bonds mature, Greece would have to pay its bondholders only €103 billion.
Even if the deal is successful there will be negative aftershocks.  Aftershock #1 will be the effect of writing down  €103 billion on the banks and other institutions that lent the money and aftershock #2, the need for certain companies that sold swaps, assuming of course that a CDS event is triggered, to have to pay out on those swaps. The total shock to the system could end up being larger than 103 billion, depending on how many naked swaps were transacted.

The Greek equity market is sending a pretty strong signal that the market insiders think A) the deal is going to get done and B) the ECB will step in to provide enough liquidity so that the reverberations are minimized. So assuming they are correct, the next big question that comes up is what will happen to the sovereign debt of the other PIIGS? They are all engaged in their own austerity programs and the motivation for sticking to those programs in their current forms will be significantly diminished.

If we take a look at the 5 year CDS prices for Portugal, Italy, Ireland and Spain, we see something quite interesting. The CDS market is showing optimism that there will be no chain reaction, except for the Portuguese swaps.

Click here to go to the live chart.
The Portuguese swaps have surged another 35% since the middle of January and what we may be witnessing is the commonly used "pick off the next weakest member of the herd" strategy. The bearish bond investors will go after each country, one-by-one, in order from weakest to ('strongest' isn't the right word in this context) least weakest.

Now if the deal were to fall apart, be prepared for all kinds of craziness, and not the good kind.

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