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Credit Insights

Devil in the Details of Forthcoming European Bailout Plan

We are concerned that Wednesday's plan may be long on rhetoric but short in specifics.

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Over the past few months, investors have been buffeted by the noise from Europe. Rumors and innuendo emanating from the negotiations to create a framework to stem the sovereign debt crisis have driven the markets back and forth. This unpredictability, seemingly without any resolution in sight, has led to a bout of crisis fatigue. As earnings season began in earnest last week and several positive economic indicators were released, investors were relieved to take a break and focus on the underlying fundamentals.

Most of the firms we follow have reported earnings in line with or slightly higher than expectations. While the equity prices of those firms that reported weak earnings may have fallen, even those firms are generally still in a much better financial position and have less balance sheet leverage than before the credit crisis. Corporate bonds were well bid across the yield curve, and the Morningstar Corporate bond Index tightened 13 basis points to +235. At the beginning of October when credit spreads hit their peak, we wrote that at those heightened credit spreads, credit risk is attractive from a fundamental viewpoint. However, while credit risk is cheap compared with our view on the credit fundamentals, we continue to be leery of how political risk will be priced into the marketplace, as the impact from European politics is always only one headline away from driving the market wider.

David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.