Euro Summit a major success! Then why is 10 year Italian yields back at 6%?

I know what you all are thinking. The bull market is back. Technical signs look good for the various indices, especially the Dow and S&P500. This all came on the back of the "comprehensive" plan that was conjured up by Eurozone leaders during last Wednesday's Eurozone summit. One has to wonder why the market rallied that much when the plans that came in were way below expectations and sketchy to say the least. Well what can I say, this is what makes the market interesting. Unpredictable and irrational to say the least. First thing that came to my mind was how right my good pal "Earn Money Online" was when he said that his fengshui indicators showed that October was going to be a positive month. Boy was he on the right track! Never get into any disagreements with Fengshui masters.

Now that the markets have shown its strength, it is time for me to admit that I was wrong about it's short term direction. Do I think that we are back on the right track? I really do not think so. The signs are still ominous in my view and what the Eurozone leaders have done over the past week was once again another kick the can down the road move. This is the 3rd plan conjured up over the past 2 years to solve the sovereign debt crisis and it would be foolish to think its the last. The measures that have been announced do not address the real issues which led us to this situation. The politicians seemed more interested to find ways to appease the financial markets than to think of how to resolve the underlying structural problems.

Why am I so sure that the crisis is not over? Look at the Italian bond auctions on Friday. They did not manage to sell all the debt they put up for sale and throw in the fact that they were selling it at yields that were all time highs since the Eurozone was formed. If the market was so convinced that the sovereign crisis is behind us, why was a 6.06% 10 year Italian bond auction so badly covered? Two days after the Eurozone summit, we have seen Italian and Spanish bond yields rally, it does not truly reflect optimism does it? I do not deny, I had my doubts about whether I was right to continue being bearish on the markets, but the more research I did, the more convinced I was right. So be patient. I am sure that the markets will reach a point which is cheaper than what we saw on Oct 3rd, 2011.

In the mean time, I know it is hard to sit on your hands while the markets rally, but trust me, the rally will stall very soon as we approach the upper boundary of the current trading range.

I am not going to dissect the various measures proposed during the Eurozone summit because they really are not worth speaking about. The amounts were too little and most of the measures defied common sense and logic. All I can say is, if a 50% haircut is considered voluntary and does not trigger a CDS payoff, then who in the world is ever going to pay an arm and a leg to buy CDS protection? Do you know how much was being paid by investors to insure against Greek debt before this deal was done? Desperate times calls for desperate measures, these include totally screwing with the system. Now I will question the validity of checking CDS spreads for risk aversion going forward. Giving the Greeks a haircut of 50% on their debt means that their debt to GDP will be around 120% by year 2020. Does that sound a little high to any of you? 2020 seems like a really long time away.....God knows how many of us will still be around to see that day. Throw in the fact that the whole of Greece is no longer functioning and their economy is shrinking by 5% this year alone, what makes you think they will be able to honor the other 50% of their debt.

Portugal and Ireland will probably need to get haircuts in 2012 as their debt loads look too heavy considering their current turtle like growth rate. What do you think the haircuts will be? Lets not even consider Spain and Italy in the picture, or else it will get too depressing. Looking on the bright side, Portugal at least has the option of selling Christiano Ronaldo to Singapore, to aid us on our goal to finally reach the World Cup finals by 2030. Poor Ireland...no talented footballers to sell to help them cope with their deficits.

Now moving on to the banks. Yes I know what you are thinking, they are going to be recapitalized. That is good news. But considering the fact that companies in Europe are the most dependent on bank financing for their businesses, this is going to kill them. Why? Because the banks are all going to be shrinking their balance sheets to conserve their cash. Every 10 dollars invested in Europe, 8 bucks is borrowed. Do the math, without the banks lending freely, business investments in Europe is pretty much screwed.

Anyway, its now in the middle of the night on Halloween, it is not wise for me to stay up too late. Not going to keep writing too much about how silly the Europeans are, at the risk of me bumping into any supernatural entities. Have a great week ahead!

Best,

SVI