Market prices are what they are

Market prices are what they are, and it is an exercise in futility to argue with them; if you think they are too low, buy; if they seem too high, sell; or you can just stay away if they look too confusing.

As I am writing this note, consider this.  The French 10 year euro-bond yields 3.511% p.a. to maturity.  This bond is rated AAA.  The Brazilian 10 year dollar bond yields 3.486%, yet it is rated BBB.  Finally, the Colombian 10 year dollar bond yields 3.662% and is rated BBB-.

In other words, markets rank France just below Brazil whose credit rating is eight levels below, and only two levels above the investment grade floor.  Markets put France barely above Colombia which is rated nine levels below and barely investment grade.

Most musings by the press and economists point to France’s credit rating being lowered but remaining within the high investment grade zone (AAA to AA-).  But markets put France barely within the investment grade category; markets price in the possibility of a small loss or haircut. 

Actually, “small haircut” is an oxymoron: no country will be forced or willingly go into default simply to reduce its debts by 5% or 10%.  Rather, the small loss is actually an expected value: a given level of haircut or loss times a probability number.  So is it 30% x 2%? Or 20% x 10%?  Who knows. 

What markets are saying is that this probability number is no longer zero and that, barring strong European political will (which is so far conspicuously absent), it could be anything.

On the other hand, one could also question how strong the economies and financial systems of Brazil and Colombia would be if Europe were to spiral into chaos and the US would continue to twiddle its thumbs.  With all due respect to Brazil and Colombia, I have always thought that emerging market investment grade was another oxymoron.

So what will it be?  It is fair to say that France is no longer a AAA borrower, at least not until it makes some reforms that it has shied away from.  It is probably a AA- or an A+, three to four levels below AAA.  At the same time, I cannot rationalize buying Colombia or Brazil at current yield levels.  Would you buy buy Brazilian or Colombian bonds paying a nominal annual return of 3.5% to 3.7% if you had to hold them for 10 years, come what may?
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Unless you are convince that a Japanese-like decade of deflation is coming, I find it very difficult to buy any sovereign bond at current yields.