Before discussing Greece I wanted to briefly hit on the U.S. economy. We previously discussed the slow climb we’ve had out of a deep hole from 2008-09 and we had another speed bump earlier this year. But there has been some good news – the economy seems to be exiting the funk it entered just a few months ago.
You can see it in the pick-up of job creation in April and May, according to data provided by the U.S. Bureau of Labor Statistics. You can see it in the faster pace of housing sales in the all-important spring selling season (National Association of Realtors, U.S. Commerce Department). And you can see it in willingness of consumers to spend (U.S. Bureau of Economic Analysis).
That’s a plus for S&P 500 company profits, which are forecast to rise a modest 2.2% in Q2 versus one year ago, compared to an estimated decline of 2.8% expected at the start of the quarter (Thomson Reuters).
MTD %YTD %3-year* %
Dow Jones Industrial Average-2.17-1.1411.01
S&P 500 Index-2.100.2014.84
Russell 2000 Index0.594.0916.23
MSCI World ex-USA**-2.992.698.23
MSCI Emerging Markets**-3.181.671.23
Source: Wall Street Journal, MSCI.com
But this month, I want to turn my attention to the international arena. In one word, it’s Greece. Greece is a small nation in southern Europe. In 2014, the U.S. exported $773 million in goods to Greece. That compares with a U.S. economy that totals over $17 trillion (U.S. Bureau of Economic Analysis).
Greece is a beautiful country that is rich in history and culture. However, simply from an economic standpoint, Greece is too minor to have any effect on thereal U.S. economy. The worries that are bubbling to the surface are squarely focused on the credit markets, the financial markets, and the banking system. This could have an impact at home.
I’ll get to that in a moment, but before I jump in, a brief history may be helpful to those who aren’t sure what the headlines are about.
December 2009 Credit ratings agencies downgrade Greece on concerns that it could default on its debt.
May 2010 Europe and Greece reach a $146 billion rescue package, which is conditional on austerity measures – first bailout.
March 2012 Private-sector creditors agree to massive restructuring and some write-downs of debt, which frees up more funds – second bailout.
January 2015 Greek voters choose an anti-austerity party that resides on the far left. Alexis Tsipras becomes prime minister.
February 2015 Greece and eurozone creditors extend bailout agreement until the end of June; both agree that any new funds will include reforms.
May 2015 Greece quells fears of an imminent default, authorizing a big loan payment to the International Monetary Fund (IMF).
June 2015 Greece defers a series of debt payments to the IMF until the end of June; it misses a 1.5 billion euro payment to the IMF due June 30.
Sources: NY Times, CNNMoney
Should the latest blow-up be a surprise? Well, not for students of economic history. You see, since Greece became an independent nation in 1829, it has been in default or rescheduling its debt 51% of the time through 2006 (First Trust).
This most recent crisis started in 2009, so financial markets have had plenty of time to prepare. At least that is the prevailing wisdom.
What’s different this time around is that Greece no longer has an independent currency – the drachma. Instead, it is part of the 19-nation European bloc that shares the euro.
No nation that has traded in its old currency for the euro has ever torn up the contract or has been forced to give up the euro. Such an event, if it were to occur, creates a heightened level of uncertainty because markets are woven together.
Short-term, stocks do not like added uncertainty and that accounts the nearly 2% selloff in the Dow on June 29 (MarketWatch).
But let’s put that into perspective. A 350 point daily loss in the Dow does grab headlines, but it is modest when compared with the 4.4% drop registered the day after Lehman Brothers collapsed in September 2008 (Wall Street Journal). Furthermore, the dollar, which we might have expected to surge on safe-haven buying, was little changed against the euro. That could change in the days ahead as this is good short-term barometer of risk.
The June 29 drop in stocks may have just been an excuse to sell, since the decline was preceded by an inordinate amount of complacency in markets over the last couple of months. While Greece has been in the headlines, there had been a general expectation that we’d eventually get some type of “kick-the-can-down-the-road” deal.
Put another way, it would have been a cleverly crafted headline that offers modest progress but fails to address the fundamental issues. It just buys more time.
The financial plans we recommend take into account bumps in the road. Because no knows the future with certainty, it sometimes surprises us when we get big daily moves. Stepping back and taking a broader perspective, it really shouldn’t.
As I’ve counseled on repeated occasions, look past the daily gyrations and keep your focus on the financial plan. The long-term, disciplined investor is the one who has historically been rewarded. The childhood story of the tortoise and the hare comes to mind.
Let’s get back to the central issue – credit markets
Economically speaking, remember that Greece is too small to impact the global economy. But if it can create significant tremors in credit markets – think the fallout from the collapse of Lehman Brothers in September 2008 – it can leave its mark.
Unlike the Greek crisis of 2010 and 2011, the private sector holds very little in the way of Greek debt – eurozone banks hold about $6 billion (MarketWatch, JP Morgan). Most of it is held by the IMF, the ECB, and European governments Therefore, it is less likely a Greek default would spread across Europe and roil credit markets.
Skeptics, however, would argue that we’re set to enter uncharted waters, raising the possibility of something more serious.
In the aggregate, about $350 billion of Greek debt is at risk, but only around $40 billion resides in commercial banks. Out of that $40 billion, $14 billion is owed to U.S. banks (Guggenheim Investments, MarketWatch).
It really isn’t very much, unless a large bank or hedge fund is overexposed to Greece. In 1998, the collapse of the hedge fund Long Term Capital Management nearly created a financial crisis, which was averted with a hastily arranged rescue package.
Where do we go from here?
For now, the situation is tense and extremely fluid in Europe.
Greek Prime Minister Alexis Tsipras surprised markets when he called a July 5 referendum on creditor demands. A ‘yes’ vote would likely keep Greece in the eurozone and soothe investor anxieties. Still, a deal has to be inked that releases more aid. A ‘no’ vote creates more uncertainty and could force Greece from the eurozone.
Previously, there was the automatic assumption that a default would result in a return of the drachma (its former currency), but that’s unclear at this juncture. A number of possibilities exist, including a parallel currency in Greece.
Or Greece may acquiesce and agree to creditor terms prior to the vote, as reports suggested early in the month. Again, the situation is fluid.
The general consensus suggests that, (with their relatively minor global production & consumption) while it would certainly be difficult short term for the Greek people, a default by Greece should not create treacherous conditions for global financial markets on its own. That would not have been the case in 2010 or 2011 but it is probably the case today since markets have had time to adjust. The bigger concern long-term could be the domino effect on countries like Spain and Portugal, who are similarly vulnerable with far more sizable economies, as well as the impact that it could have on global credit markets and banking systems. It is obviously something that we will continue to keep a close eye on and will discuss further in a few weeks during our 2015 Mid-Year market outlook webinar as things develop further.