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Morning Glory: Will the European Solution Trigger a Selective Default?


Traders posture into the long weekend.


Big news on the global financial market front; game-changing news. News you should be aware of.

The ECB plan to shield its Greek bond holdings from restructuring will subordinate private investors-the ECB would receive preferential treatment-and that could trigger a CDS event if a coercive default takes place, according to UBS strategist Chris Walker.

That is my gut too, although there is some debate about this in Minyanville Headquarters. If you're a private investor and your bonds were suddenly knocked down the financial food chain, you would scream bloody murder that your credit default swaps should trigger.

The early price action is celebrating this news and while the market is never "wrong," I would ask that you pay particular attention to the chasm between perception and reality. The perception is that we've side-stepped a land-mine; the reality, and what is not yet factored into current levels, in my view, is the psychological impact of this ECB debt swap.

If and when investors begin to wrap their keppes around the implicaitons of this, the ramifications could be profound. Remember, as we first postured in 2007, credit of a different breed--that of credibility--will be the issue at hand for markets at large.

I asked MV contributor and Financial Insyghts CEO Peter Atwater his take on the matter, and he responded as follows:

I've been talking about this risk for some time with my clients.

Central banks always come first - whether as holders of sovereign credit or as secured lenders to banks.

People are just now waking up to this.

So long as default wasn't an option, nobody cared - both for Greece and for the banks. Now that default is happening, the issue is here front and center.

But think about what this means with regards to the LTRO? Every new euro the ECB lends means somebody else has likely moved further back on the bus.

What concerns me about that is that some of those somebodies are potentially retail depositors. This sets up a very interesting situation in which a failed bank could have depositors standing behind the ECB to get paid out. And as those depositors are likely to be a national government, you could have a sovereign nation fighting with the ECB to get paid.

To me it all boils down to the distinction between liquidity versus capital.

Someday people will learn the difference.

One Foot in Front of Another

While the expiration volatility manifests in the days prior to the actual expiry (today), expiration itself is usually busy on the bells (index options expire in the morning, individual stock prices expire on the close) and quiet in the middle.

The twist, of course, is that we're edging into a long weekend, and while derivative influences will push prices around, the over-arching risk appetite will help shape the flavor of the tape into our requisite respite, one that is no-doubt needed around the Street.

For my part, after covering the meat of my short-side exposure yesterday morning (as discussed real-time on the Buzz, and yes, it's better to be lucky than smart), I returned to MVHQ in the late afternoon and added back a layer of short exposure in both the S&P and NDX in an attempt to use the price action to my advantage.

As I will be saddling up at high noon to drive the Harrison Family Caravan to the mountains-and returning Tuesday afternoon, as I'm told-my inclination is to pare risk rather than add to it as a function of time and price. I'm conscious that S&P 1360 is upon us (the price-target we eye-balled in December 2011) while remaining equally aware that overbought conditions can be worked off as a function of time rather than price (Hoofy will argue this is a bullish basing, as per the S&P chart below).

The financials (above BKX 42), Apple (AAPL) and expiration (even if you can't see it) will all shape the tape as we together find our way today. In terms of the next meaty leg to for the market, that will be dictated by today's news once investors have an opportunity to digest it.

Good luck today, and have a tremendous holiday respite!


Twitter: @todd_harrison

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Position in NDX, SPX
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