Farrell: Sell Greece Again?
Chief Investment Officer, Soleil Securities
I was hoping we could forget about the Club Med countries for a while.
But reading through everyone else's research this morning (where else would I get my ideas) I came upon "Credit Default Swaps" for Greece. Remember, they are like insurance policies that pay off if a company/country defaults. So I might sell you a policy insuring you against loss if the U.S. or GE or Britain or Greece or whoever defaults on its debt.
You might want to buy such a policy.
Each policy is separately written and the price is negotiated between two supposedly intelligent, well informed participants. AIG wasn't as well informed as they thought when they wrote a bunch of these and maybe Goldman was when they bought them.
At the height of the tension surrounding Greek debt, CDS's as they are lovingly called by those of us that think we know them (and clearly no one knew them well enough - except maybe Goldman), the premium for insuring Greek debt was 1004 basis points. That meant it cost EU 1,004,000 a year to insure EU 10,000,000 of bonds. Each year for typically five years. Such a price is a very clear statement that most of the world thinks default is imminent. As things calmed down the premium receded to under 900 basis points.
Still abnormally expensive.
The price spiked yesterday to 961, which is EU 961,000 a year for five years.
Default is back on the table.
I had hoped the rescue package would buy some time. Maybe it will but the G20 meeting this weekend will be "fun". Most of the world wants Germany to spend its money so the rest of them can export their way to heaven. Germany says it is fiscally responsible and will not follow the path of layering on debt to help the profligate.
I hope they have a lot of wine on ice to mellow folks out.
At the same time it looks like our Uncle Benji is a genius. His Fed bought $1.25 trillion of mortgage backed securities to help stabilize the mortgage market. I guess it did but it does look like our housing industry is having indigestion post the MBS buys and the expiration of the tax credit for new home purchases. But the price for that MBS stuff has soared in the aftermarket. Bloomberg news has reported that mortgage securities are at record prices as the supply is limited and homeowner refinancing is lagging expectations. Bank of America Merrill Lynch Mortgage Master Index (how is that for a title ) prices the $5.2 trillion of total debt outstanding at a record average price of 106.3. That would be $1063 dollars per $1000 par amount. That is up from a 104 when the Fed stopped its purchases on March 31.
The supply of new paper which would effect prices is limited since mortgage applications are down 57% from last January's peak. That despite record low mortgage rates. About one quarter of homeowners are "underwater" on their mortgages, meaning they owe more than the house is worth. Refinancing is not possible, of course, in such a situation. I don't know who Ben would sell to, but on paper the U.S. has a significant profit.
I saw it earlier at a .645% yield. That hardly seems possible. The 10 year yield is now below 3.10%. The question is why would you buy 10 year paper at such a low yield unless you thought deflation was a possibility? I think it's a possibility, but not yet a probability.
I get the privilege of enjoying email exchanges with some really smart people around the world. My pal David Rosenberg labors in Toronto for money manager, Gluskin Sheff. I think it's fair to say he sees a much greater chance of deflation. In fact he says in his latest missive, "the Treasury market is screaming deflation."
Markets can reverse themselves, can go to extremes that need to be compensated for, or just be wrong. But if deflation is on the horizon, earnings estimates are at risk as is the 1035-1040 level on the S&P. I have been saying that the 1035-40 level (a one-third correction of the total advance since March 2009) would be the bottom end of a trading range the market often settles into as the world sorts through the economic outlook. The result of the sort-through is allowed to be a negative opinion.
I'm hoping not, but we'll find out soon enough.
Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.