Owe too much money? Don't worry, leverage up to bail yourself out. That is Europe's suggested solution!

Today is of those days when I decide to take a day off and sit down to look at the market from a personal perspective rather than for work. It is amazing how a day off can help a person regain some perspective about not just the market but also his life. As expected, the markets this week have been rather tepid while waiting for the Euro summit to takE place this Sunday. Expectations of a magic bullet are as high as the discontent amongst the Greeks as rallies turn violent and pictures of protesters are splashed across news channels.

For those of you who loves to watch dramas and movies, I would strongly recommend forgetting about your HBO and tune in to CNBC instead. Last night for example was a great example of how the twists and turns in the news coming out of Europe is just as intriguing as an episode of CSI or 24. If you had watched CNBC last night, you would have seen that the night started off with the EFSF discussion guidelines being leaked out to the press and brought some relief to the market. Following closely after that piece of good news, was the German finance minister commenting that germany and France had come to an agreement of an accord with regards to the new enlarged EFSF. Just when the markets were cheering this piece of news, an newspaper in Germany released the news that Merkel had cancelled her scheduled speech to the parliament with regards to the new EFSF plans. What a damper! Shortly after that, news of then possibility of another euro summit meeting being held next wednesday to finalize all the plans just got the whole market confused. Imagine that! All that in one night! Being very much a couch potato myself, I skipped a couple of my favorite movies on HBO and was glued to CNBC till 2 am.

Jokes aside, this week is ending on a strong note with plenty of investors wading into the market in the hopes of a strong plan being announced by next wednesday. Plenty of short covering happening here too. Speculation in rife with regards to the possible moves that may be implemented and they do sound interesting. But what really worries me is that the summit has been postponed twice already. I am not in the camp of believing that the countries are reaching agreement on what to do to resolve this mess. Even if they are in agreement, it does not mean that the compromised solution will be sufficient to solve it.

Last week, I mentioned that Italian 10 year yields are close to 6% once again and that worried me. This week, we touched 6% once again. The equity markets seem to be pricing in a solution to the Euro crisis but the credit markets are telling me another story. If we are so close to resolving everything, shouldn't the sovereign bonds be reflecting some of that? Well they are obviously not. One reason I can think of is that the participation in bond markets tend to be institutional investors while equity markets have substantial retail presence. That is why I believe that the smart money is still staying in the sidelines and not buying into the resolution story.

It is also interesting to note that Moody’s Investors Service downgraded Spain’s credit rating Tuesday and warned that France’s rating could also be at risk, citing both nations’ vulnerability as Europe struggles to manage it is persistent debt crisis. A hit on the French credit rating would seriously undermine the effectiveness of any bailout backed by AAA debt holders of Europe.

Another important thing to look at the composition of the EFSF to understand where all the money is coming from. It is ironic that Spain and Italy make up 12% and 18% of the contributions to EFSF. If only such a simple solution existed, the underwater U.S. homeowner would have loved to bailout himself. France is also a significant 20% which implies a hit on French credit rating undermines the EFSF. If France gets downgraded, the number of AAA rated countries backing the EFSF will drop to a pathetic number. Credit investors are also acting as if the EFSF is not a AAA rated issuer because its bonds are all trading at close to 100 basis points above that of similar dated German bonds. So if France gets downgraded the EFSF bonds will need to have higher yields to attract investors.

In my opinion even if a solution is announced over the weekend that is received well by the market, it will not be long before we are back to square one and another PIIGS-driven European crisis is front and center once again. Sweeping our problems under the carpet has never solved any problems and this will not be any different.

In conclusion one has to be skeptical about the European bailout plan and one has to keep in mind that we can’t solve a crisis which was caused due to excessive leverage by re-deploying leverage. Using more debt to solve debt issues will never be a solution and this is exactly what European leaders are proposing to do. You would have thought that they would have better sense to know that structural issues are not solved by throwing money at it. Lets hope they will wake up and acknowledge the need to assist these nations to improve structural competitiveness rather that pushing them to go through more austerity measures and thereby causing their economies to contract even further. Sigh....it is worrying to see that the guidelines on the plans being discussed in this Euro Summit does not address the real issues that are underlying this crisis.

Well all the best for the coming week!

Best,

SVI