Daily State of the Markets
Good morning. Maybe it's the jet lag talking or perhaps I've simply become a little cynical after 25 years in this business. But, yesterday's action sure felt like a case déjà vu all over again as the fast-money types (who are arguably the only people in the game that react to each and every headline, each and every minute of each and every day) appeared to open up the playbook on sovereign debt crises again and make the prescribed trades.
Let's see, the playbook says that you should first bid up the credit default swaps on the country in question - in this case we're talking about Italy. If you're lucky, you might get a nice headline such as "The world doesn't have the cash to bail out Italy" or "EU considers partial default in Greece" to help convince your bearish buddies to join in on the fun. If enough people jump in, soon there will be talk of spreads "blowing out" and new record prices for buying insurance against a country defaulting on its debt.
Speaking of bonds, they are the vehicle of choice for those looking to keep things simple as selling bonds (and maybe some derivatives thereof) is another way to pump up the fear factor in the sovereign debt trade. Remember, higher yields (caused by lower prices) makes it more difficult for an embattled country to borrow money, which, in and of itself, makes the situation more problematic. Which, of course, creates more incentive to bid up the CDS's and sell the bonds, and okay, you get the idea.
Next, the playbook suggests that you might want to cover your asset classes and do some shorting of equities in the country currently under attack. And if you've got the capital, why not lever it up a bit with margin and the use of an option or two. Oh, and if you want to really make a statement, you can go ahead and run sell programs on any other country or region that may (or may not) be in trouble.
If things go according to the playbook, all of your efforts will get noticed in the wee hours of trading in the good 'ol USofA and the futures will start to be sold off as fear of "contagion" knows no borders. And for those looking to raise the bar on the degree of difficulty on the trade, chapter four says you can go ahead and buy gold, dollars, and U.S. government bonds.
In case my point isn't clear, I'm of the mind that this is what was taking place on Monday. And then when you mix in the sovereign debt playbook with an overbought market that is also uncertain about the state of the economy, the strength of the upcoming earnings season, the political games occurring in D.C., and the goings on in China, well, you've got the makings of an ugly day on your hands.
To make matters worse, every trader worth their keyboards knew that the major indices were within spitting distance of the old cycle highs. This may have caused some to wonder if things had improved THAT much over the past eight trading sessions or if earnings were going to be robust enough to justify new highs and blue skies ahead. And with an obvious trading range continuing, the long-only crowd may have decided to sit on their hands yesterday.
The bulls argued Monday that we've seen this movie before and that the EU/ECB/IMF (and maybe the central banks of other nations such as China and the U.S.) are unlikely to let anything really bad happen. In response, their opponents pulled out an oldie-but-a-goodie by suggesting that Italy isn't Greece and therefore, this time it is different.
So, with traders opening up the sovereign debt playbook and some uncertainty in the air on a handful of topics, it is little wonder that the indices had a bad day. The question now, of course, is how bad things will get before the next batch of good news shows up or the dip buyers decide to do their thing.
Turning to this morning... Despite reassurances by the EuroGroup, fears regarding credit contagion are running high once again this morning. CDS spreads are continuing to "blow out" while bond yields on Italian bonds have spiked higher. In addition, Cisco's surprise announcement that it plans to cut 10,000 jobs is weighing on sentiment.
However, there are rumors that the ECB is stepping into the currency markets this morning, which has created a bounce in the futures.
On the Economic front... The NFIB Small Business Optimism Index fell -0.1% in June to 90.8. Next, the U.S. Trade Deficit fell in May to $50.23 billion, which was above than the consensus estimate for a deficit of $43.83 billion.
Thought for the day... Just for fun, try smiling at everyone you meet today...
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