10/26/11   When Is A Default Not A Default?

Editor’s Corner

Investor Heat Map: 10/26/11When Is A Default Not A Default?

Ron Rowland

European leaders met yet again to discuss their Continent’s sovereign debt crisis.  The latest reports center around the size of “haircut” Greece’s creditors will accept.  An agreement struck in July forecasted 21% losses for noteholders.  Now 50% and 60% are the numbers being thrown around.

The overriding objective of all parties is to avoid a formal “default” by Greece.  Why?  One explanation is that such an event would trigger credit default swap contracts written years ago by some of the very same banks.  The hit to capital would be immediate, but identifying its size and distribution is amazingly complex.  The complicated agreements are often hedged in multiple ways, too. 

The CDS market for Greece is relatively small, but default there would pressure larger countries like Italy and Spain to do the same.  Systemic risk could be massive.  This would explain the willingness of banks to accept capital write-downs that would constitute “default” in any other context.  It also explains the desperation of politicians to help make it happen.  The negotiations may represent an existential threat for some institutions, which might be the reason they are fighting so hard.  They have no other choice.

Meanwhile, the U.S. economy showed a few signs of improvement but nothing resembling recovery.  Equity benchmarks are extending the upper limits of their trading ranges.  Reports this afternoon that China might invest in Europe’s bailout fund were helpful, as was news that European leaders had agreed to a bank-recapitalization plan.  As noted above, the devil is in the details – and the details are still veiled in secrecy.


Technology lost its top ranking to last week’s runner-up, Consumer Discretionary.  Tech benchmarks initially shrugged off earnings disappointments from Apple (AAPL) and IBM (IBM) before losing momentum.  Consumer Discretionary may suffer a similar fate if Tuesday’s report from Amazon (AMZN) is repeated by other companies.  Utilities held on to third place, which is quite a feat for a “defensive” sector in a market starting to again embrace risk.  Energy kept climbing along with crude oil prices and grabbed fourth place.  We now have seven sectors with positive momentum.  The three exceptions are Financials, Materials, and Telecom.  The Financials sector is very close to a positive reading, but to us this looks more like an oversold bounce than a new uptrend.


The relative Style rankings are still in the same order they were a week ago, but the overall picture has changed dramatically.  Every category except Micro Cap now shows positive intermediate-term momentum.  The magnitude of the uptrends is small but encouraging, given the disruptive market of the last few months.  That said, a continued preference for larger stocks suggests buyers are still uneasy.  Growth remains ahead of Value at every level.


Categories beginning with the word “United” remain atop the Global chart.  The United Kingdom expanded its lead over second-place United States.  The European Union, which is presently anything but unified, is still hovering in the middle of the list.  Japan fell back into the lower tier.  Even an all-time high for the Yen/Dollar rate could not overcome a languishing equity market.  Canada slipped down the list as well.  China stayed in last place despite some positive economic data.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Work’s not been done yet, but everyone’s coming here today with the goal to progress quite a bit.”

German PM Angela Merkel, on her way into EU summit meeting, 10/26/11


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