PIIGS Crisis Is Benefiting Japan.

Marc Faber's "bowl of liquidity" analogy, showed us how as a result of the European sovereign debt crisis, money could flow out of PIIGS debt and into equities. I wanted to provide a little more color given the events of the past couple weeks as the crisis has moved from Ireland and Portugal to Spain and Italy.

In the chart above, tells a different story. Here, the Euro Stoxx chart is in orange, the S&P 500 is in white, and the Nikkei is in green. And we see that since the Spain/Germany spread bottomed on October 26, the Euro Stoxx is down 6.5%, the S&P 500 is up 0.2%, and the Nikkei is up a whopping 8.0%! Whoa, what's going on?

What I believe to be happening is that with the current crisis being one more of solvency than liquidity (though Spain may have something to say about that), instead of markets being simply "risk on" or "risk off," idiosyncratic factors are coming into play as global asset allocators evaluate their options. Due to the PIIGS crisis, borrowing costs are rising for the European sovereign market -- yesterday was scary because not only did Spanish 10-year yields rise 25bps, but German 10-year yields also rose -- which feeds back into the private market for European borrowers in the form of more expensive credit. Austerity measures impact growth prospects. And allocators, aware of this, are moving money out of Europe -- not just sovereign debt but equities as well. European-focused funds may be experiencing redemptions, and oftentimes portfolio managers are forced to sell their most valuable assets that still have liquidity (equities) instead of the distressed ones they'd like to unload (sovereign debt). And this money is finding its way not just into real safe havens like US, German, and Japanese debt, but the US and Japanese equity markets as well. After being neglected for so long by investors, the smallest trickle of inflows into the Japanese equity market could create a surge along the likes of the commodities market in the earlier part of the last decade.

This is not to say that it's time to load the boat with Japanese and US equities. The crisis has still not passed. If Spain or Italy seizes up it could do untold damage to all asset markets with the liquidity crisis returning for awhile. But I believe that correlations are breaking down as the crisis shifts from one of liquidity to one of solvency, and when solvency crises intermittently create liquidity crises it's time for investors to think about what to own while assets with true value are being treated no differently than ones that truly might go to zero.