Daniel's View on the Market

Since late last week, the stock markets around the world have succeeded in gaining some grounds that they had lost for the last few months thanks to Merkel and Sarkozy's agreement on bailing out European banks.
However, there is no doubt that both leaders share different views on many issues surrounding bailing out the ailing PIIGS. For one thing, French banks have a large exposure to Greek sovereign debt and 50~70% haircut or default will lead to huge losses on the assets they hold. If the French government comes to the rescue, the cost to help out the French financial institutions are not immaterial compared to its GDP level that a credit downgrade is likely. In order to avoid this, Sarkozy maintains that EFSF be used first to save the banks. Germany, the Netherlands and Austria, however, sees EFSF as the last resort (after all the options are dried out such as taking losses at debt holder and shareholder levels first before resorting to EFSF contributed from all the EU member states using taxpayers money).

In other words, on the surface, things seem to be getting better, which has led to four days of market rally.
However, I believe that the kind of rally we've seen in the last four days will reverse its course despite the fact that the stock prices are still really down compared to what they were few months ago. The market is demanding around 150% yield on 1-year Greek debt, which only tells that the market is already pricing in Greek default. No matter how Greece passes and implements its austerity measures, the bottom line is that the country has no solid manufacturing industry from which to generate stable revenues to generate positive current account balances and pay off debt.

To make matters worse, the EU, by its size and design, is not nimble enough to react to crisis in a timely manner. The TED spread is still too high and the European banks are not willing to lend to each other judging by the larger amount of money deposited in the ECB accounts. All in all, I do not believe the crisis is over any time soon and the market will continue to be volatile more to the downside than upside.