In My Opinion: Digging Deepr Into Last Week's Blast

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Another Way To Look At Last Week's Run

I've been pondering a question for a while now... Why the huge run on Thursday?

Conventional wisdom has put it that the markets jumped in celebration of the "Grand Plan".

Here is a slightly different view I came across during my weekend review.

The brief bullet points are as follows:

• Banks took a "voluntary" haircut of 50%. Voluntary in the sense that Merkel and Sarkozy and the gang told them to volunteer or the alternative would be worse.
  
• Because the debt haircuts were "voluntary" there was no "Credit Event" and therefore there was no triggering of Credit Default Swaps. (B.T.W. - Charles Dallara, managing director of the Institute of International Finance, was part of the negotiations regarding the "haircut" on behalf of bond owners. He seems to be of the opinion that the deal isn't really settled yet and is reported in the Financial Times to feel that "the reduction in new bonds' net present value would not be overly onerous. 'That is very crucial to us'." And in the WSJ we have: "But some noted that the I.I.F., negotiating on behalf of the private sector, had committed only to 'work...to develop a concrete voluntary agreement' on Greek debt. 'An invitation to agree to a haircut is not the same as a haircut,' said Sony Kapoor, managing director of economic and financial think tank Re-Define.")
  
• That led to a number of Credit Default Swap dominos falling. Now carefully follow this sequence: Investor "1" has bought CDS on a given bank "A" (such as Morgan Stanley or JPMorgan, but it could be any bank) because investor "1" feels "A" has too much CDS risk in say the Sovereign Debt market. Investor "1" buys the CDS from bank "B" (again any bank such as GS, JPM, etc.). Bank "B" hedges their risk buy shorting some bank "A" stock. Or, if its CDS risk is big enough, it may choose to short the S&P Index.
  
• Shorts get covered. Now here's the key: with the announcement of the "Grand Plan" it becomes apparent (or, at least, so it generally seemed on Thursday) that there would not be a credit event. At that moment bank "B" suddenly finds that it will not likely have to pay out on the CDS it wrote to investor "1". That means it doesn't need to hedge its risk as much or, perhaps at all. Time to cover the shorts.
  
• Financial stocks, and risk assets generally, are bought. The risk to financial stocks in general is reduced because of the "Grand Plan" and the avoiding of a "Credit Event". Time to buy some financials.
  
• Long/short hedge funds get squeezed. As shorts are covered and risk assets are bought some hedge funds start to get squeezed, especially those with a bias against the financials. Time to act to cut losses.
  
• And things begin to snowball. HFT's and quants start to move. Got to get on board this train.
  
• In come the momentum players. It moving. Gotta buy 'em.

And the entire global equity market complex melts up. Just one possible line of thinking, but a reasonable one in my opinion.

 

Have a good one...

Curtis Bergquist
Co-Manager: Daily Decision-PRO

P.S. Here's an unabashed pitch for Daily Decision-PRO Service - It's beaten the market handily for five months running now.

 

  S&P 500 - Last 12 Month

 

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