Hussman Weekly Market Comment: Not Over by a Longshot

On Friday, the yield on 1-year Greek government bonds closed above 135%. As I've noted in recent weeks, the bond markets continue to reflect expectations of certain default on Greek debt. All they are working out now is the recovery rate. As of last week, the expected recovery rate implied by bond prices stands at about 43% of face value. Since Greece is still running a primary deficit (it can't pay its bills even if debt servicing costs drop to zero), my impression is that the eventual default may be even worse. Still, if I were to venture a guess, it would also be that Greece will be given a small amount of new funding in the coming weeks in order for the government to continue running and delay the inevitable. The reason is that Europe needs time to better prepare for a default, and European leaders appear to be scrambling to get banks to bolster their capital as quickly as possible (somehow investors responded to that news with a short-lived rally last week, as if the need to accelerate the timeline for banks to acquire additional capital is a good thing).

If you're attentive to how European leaders are phrasing things these days, you'll notice that (except for officials in Greece) they've stopped saying that Greece itself will not be allowed to default, and instead insist that the European financial system and the European monetary union will be defended. While it's possible that the equity markets will mount a relief rally in the event of new funding to Greece, it will be important to recognize that handing out a bit more relief would be preparatory to a default, and that would probably be reflected in a failure of Greek yields to retreat significantly on that news.