The Rain in Spain Renews Fear and Pain

I will trade you Spain for Greece? The worries about Greece leaving the EU and defaulting on their sovereign debt has been a concern for more than a year. Now the focus shifts to a bigger problem with Spain. Tuesday’s gains are in position to evaporate on the new worries rising that Spain may need help as their banks need capital to maintain liquidity. Thus, Europe is taking the lead relative to worries, and the economic data due out this week will be overshadowed. However, if the data is bad or worse than expected it will add to the anxiety and fears which could be the catalyst to retest the 1295 lows on the S&P 500 index. The next phase of worry is in play and the downside bias is back relative to sentment driven by Europe.

Spain become the new speculation point for the both the EU and the euro. The reveresal in the euro in Tuesday’s trading sent the price below $1.25 and closed at a two-year low. The continued push higher in the dollar as a result isn’t likely to end anytime soon. The bigger question looms about Spain exiting the EU as they don’t see eye-to-eye with the ECB or EU. The impact of this speculation is being felt around the world today as stocks were off in Asia, lower in Europe and the US futures are trading lower. Spain is the twelth largest economy in the world. The impactc of a default on sovereign debt will be felt globally. EWP, SPDR Spain ETF shows the falling price of stocks in repsonse to the building concerns shedding one-third of the value since February. This remains a key issue for the markets short and long term.

China was up 4% on Tuesday on the rumor more stimulus was on the way to spur growth in their economy. There is plenty of speculation relative to how the stimulus will be rolled out, if at all. The move off the lows is worth watching here as a opportunity to add to the short position as FXI has dropped 11.6% since the high in April. The bounce does establish a potential pivot point or reversal to watch short term. If we hold and reverse the downtrend we look at the upside play opportunities. However, the more likely action will be short on the renewed selling if the Chinese government fails to deliver on the expectations of more stimulus. The speculation is already building that the rumors were wrong. Look for the gains from Tuesday to fade and the low to be tested again.

The credit risk concern in both Spain and Greece are creeping into the US bond market. High yield bonds have pulled back 2% the last two plus weeks. Investors are willing to give up the yield as the perceived credit risk of these assets rises. The leverage closed end funds have pulled back further short term. Floating rate bond funds equally have pulled back in price as concerns of the ripple effect to the US banks. These short term debt instruments have regained their popularity following the 2008 collapse. But the haunting memories are alive and well. Investment grade corporate bonds have been selling as well. LQD fell nearly 2%, but has bounced of the lows the last few trading days. The perception of risk prompts some to sell early and ask questions later. That is a left over benefit from the financial crisis. The volatility is worth watching from two respects, first the buying opportunity of speculative selling not panning out and creating longer term value. Second, the short opportunity if the selling accelerates. Billions of dollars have poured into bond ETFs and bond mutual funds over the last two years looking for higher yield alternatives to the zero percent Bernanke effect. If the fear syndrome rises in the debt markets the run on the bank, so to speak, will be worse than a stock market sell off. Watch your positions and plan an orderly exit if the downside develops.

The wall of worry is building again and there is little to prevent the effect. As investors we have to weigh out logically what our options are as it relates to our portfolio. We have to take what the market gives whether good or bad. As the downside fears build paring positions and raising cash is an option. If the fears are validated we avoid the downside impact to our portfolio. If the fears are invalid we can always buy positions back and the only thing lost is opportunity. Principle perservation is the name of the game which is money management at work. The warning signs have been