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Spain, Spain, Spain.

The reality is that Greece is largely noise. Greece will eventually leave the eurozone, but not this month. The hardliners inside Greece will realize they need some time to organize. The markets will have spooked the hardliners outside of Greece that they should play nice for a little bit, because forcing Greece out now won't do them any good whatsoever.

With Greece largely a sideshow at this stage, the attention is really focused on Spain and Italy. The fact that Greece might lead the way out of the euro is having a big impact on these countries. That realization, combined with the already obvious problems at the sovereign and bank level, caused markets to sell off. The Spanish 10-year bond is back above 6%, dropping 20 bps today, which is a significant move. As we wrote about last Friday, there are no natural buyers, so this move occurred in an illiquid market. There is more room to run, but moves in Spanish and Italian bonds are already starting to have a less direct impact on stocks than they did earlier in the morning.

I don't think we will see a serious rebound in Spanish and Italian yields until the ECB intervenes. They will need to step up and draw a proverbial line in the sand. My guess is that won't occur until 6.25% on the Spanish 10-year bond. Once the ECB does step in, watch out for a big gap better on the bonds. Just as there are no natural buyers, there will be no natural sellers. The shorts will want to cover. No one who is short is going to want to fight the ECB, at least not on their first day of purchases, so they will become buyers themselves. The dealers will sell what little inventory they have to the ECB and will do everything they can to drive up prices and get the best execution possible on their small positions. No Spanish or Italian bank is going to sell their inventory for a loss. They might not be adding, but they sure as heck aren't selling.

The first hint of ECB purchases will be a major "risk on" signal. I don't think we get it yet, but once we get actual purchases -- or even a good rumor of purchases -- I would expect 10-year bonds to gap up a point, CDS to tighten by 30 bps or more, and stocks in Spain to do a quick 2% bounce. It will happen quickly, but I really think the ECB has too many skeletons of its own making to jump in just yet. A bit more pain in the bond markets is still coming, but it will have less of a knock-on effect on stocks than the gap to 6% had.

High yield continues to perform incredibly well. No real selling pressure, and although it may get dragged down a little with Spain and Italy and stocks, it will find buyers. The scenario for largely domestic-focused companies offering good yields remains decent and buyers will continue to be there. Hedge funds that have been waiting to buy on a dip are getting restless, and those that bought early didn't use much leverage, so they aren't getting shaken out by these small moves.

I continue to like (HYG) and (JNK) on the ETF side, though I am actually more interested in managed funds as I think the alpha a good manager can produce will create enhanced returns. The "beta" has been largely squeezed out of the high-yield market, and it is a "collect the coupon" sort of environment, so I would go with a manager as opposed to the ETFs. The same applies even more on the loan side where (BKLN) is very small so you get much better diversification with a manager, but I view the allocation to leveraged loans as even more long term. On any weakness, I am looking to increase the allocation to high yield.

I do not like (LQD) here. Investment grade bonds, without a rate hedge, make no sense to me at these levels. I shorted treasuries a bit early, but if anything will add more, as the flight to quality trade seems halfhearted these days.

I will be buying (SPY), (QQQ), and (EWP) soon.

Source: The Pain In Spain Is Mainly, Well, Everywhere!