Contagion in Europe looks more likely. At least that is what the bond markets are telling us.

Took a nice break last week, away from work and markets. Was too lazy to blog but that does not mean that there was nothing to talk about. In fact, there was so much happening that the market had a tough time digesting all the information. The past two weeks have not been great for the markets and things look like it is only going to get worse before getting better. Lets try to dissect one issue at a time.

Two weeks ago, we witnessed something which we have not seen for some time. Two governments falling. Believe me when I say this is just the beginning. Governments will fall as the world tries to get its act together. My question is, will these new governments really make a difference? Spain goes to the polls this weekend and the opposition looks like they will win a landslide victory. That makes a third new government installed in Europe in 2 weeks. In one of my previous posts, I mentioned, as governments fall, what is to stop the new governments from making radical decisions to prove their worth to their people? If that is the case, will they have the same kind of commitment to the Euro Zone? All can be said is that political risk is one that cannot be quantified and do not underestimate this.

Finally, the press is talking about Italian yields. That is close to a month too late. Yields shot all the way up to 7.47%. That all happened so quickly, the market was taken by surprise. Since that day, the markets have not been able to climb back up. The underlying weakness is obvious and we have since seen the worse week for the S&P500 since September. Yields being temporarily high is not something which should concern us because Italy does not need to refinance so much over the next few months. What the yields tell us now is that the markets are freezing up. How do I know that? Last week, there was an auction for Spanish 10 year bonds which saw the bonds sell at 6.96% yield. You may be asking why would that be something that interest you? Well the secondary market for Spanish 10 year bonds was trading at 6.60% yield. So you could buy in the primary market and sell it immediately for a nice little profit.

The reason to why there is such a big difference between the primary and secondary market is because the ECB is in the secondary market supporting prices but they do not have the mandate to buy bonds directly from primary auctions. What it tells me is that the secondary market for European sovereign bonds has frozen up. If the ECB stops buying, the yields are going to shoot through the roof. Now what we have here is a liquidity problem more than an insolvency one. However, if liquidity is withdrawn for a long period, a solvent entity can become insolvent. So continue to watch the yields closely.

One thing that makes me worried is how the French 10 year yield is at 3.66% while the German 10 year yield is at 1.85%. The spread between the two bonds are too high for comfort. Considering how both countries are rated AAA, the difference in yields may be indicating that the contagion is really here. Germany has a bond auction that was not even fully taken up last week. This shows how thin investors' confidence are on Euro Zone debt. There is also the EFSF which the world regarded as the ultimate solution for the Euro Zone debt crisis. Now the debt that has been issued by the EFSF is trading below par. That is a worry, this is a bond that is backed by all of the Euro Zone...including Germany and France. Rated AAA and trading below par. The market is obviously not regarding it as AAA. If this goes on, one has to wonder how much can the EFSF raise from investors to provide a large enough backstop for the Euro Zone. Looks like the sovereign bond markets in Europe is shedding blood while equity markets continue to meander and hope for the best. Remember "Hope is not a strategy".

While Europe is in a mess, things in the US looks brighter as most economic indicators continue to be positive. However the MF Global bankruptcy close to two weeks ago could have further reaching repercussions than we think. Of course MF Global is no Lehman, but many banks are on the hook from MF Global's demise. Be it in the form of lawsuits for selling MF Global notes or as creditors. US financials have performed really badly over the past couple of weeks. Many of them are trading close to their 52 weeks lows and one has to admit, things do not look too bright for them going forward.

One possible tricky situation for this week is the debt plan which the US debt "super committee" is supposed to come up with by 23rd of Nov. Well considering it is Sunday night and both democrats and republicans still at an impasse. This should not come as a surprise because the world knew that the formation of this "super committee" was just a delay of time tactic. The committee faces a Wednesday deadline. But members would have to agree on the outlines of a package by Monday to allow time for drafting and assessing by the Congressional Budget Office. Thus if nothing is out tomorrow, the market would not be too pleased. The US should really try to get this out of the way as soon as possible or the recent memories of the impasse they had earlier this year is going to resurface and cause more duress to the markets.

For our Singapore market, we have had a few interesting IPOs which behaved rather interestingly, rallying on pure speculation as both catalist counters are not exactly exciting in their businesses or even growing. We are seeing plenty of IPOs over the last few weeks as companies rush to list their businesses before the next downturn in the markets come along. Be very careful when dealing with these IPOs because they are really ridiculously priced. Earnings season for Singapore companies have also disappointed, illustrating the weakness in the global economy. Plenty of brokers are trying their best to release reports on when earnings will recover. My gut tells me that earnings will continue to be weak as long as the Euro Zone debt problem persists on.

Of course one of the few companies that have done pretty well during this earnings season has been LMA which I covered in the last post and Sarin did fantastic too. So both my favourites are still holding up pretty well.

Ok that is all I have to say for this week. I continue to remain bearish on the market and maintain the worst is yet to come.

Have a great week ahead!

Best,

SVI