Greece and the Markets
There has been a lot of talk in the last several weeks and months about the sovereign debt issues of Greece. To put it simply, 30 plus years of corruption and mismanagement of the economy have put Greece in a position that will make it very difficult for them to make interest payments on this debt without major intervention from other European Union countries. Unlike a country like the US which has its own national currency, Greece uses a currency that is used by several different nations (the Euro). This makes it impossible for Greece to print money for themselves and bail themselves out. Therefore, they must rely on other EU countries and the International Monetary Fund to send them money to help them pay their debt. As of this week, it appears that a deal is close to being made to bailout Greece for about $160 billion led mostly by Germany. But in order to get this money, Greece must cut a lot of benefits to the average citizen and that is what is causing the riots you have seen on TV.
I was at a conference this week with the head of SEI’s investment management unit Kevin Barr who you see frequently on our quarterly video. In addition, he had all of his portfolio managers from SEI along with him and several of the third party equity and fixed income managers were there as well. It was very interesting to hear what the managers in particular had to say about the Greece crisis. First of all, they have seen this coming for several months. In fact, they totally divested your portfolio of any direct investment in Greek stocks or bonds several months ago. Second of all, the managers fully expect Greece to have to restructure their debt. This basically means that Greece will default on their debt and the owners of the debt will be forced to settle for less than it’s worth. The reason the managers believe this will happen is because it has already happened six times since Greece became a country in the 1820’s and the managers do not think Greece’s political culture has changed enough for a different outcome this time. The third point they made was that they do not expect this crisis to be as bad in the other countries that are in the news: Portugal, Italy, Ireland, and Spain.
Greece is roughly 3% of the overall GDP of the European Union. Its GDP is roughly the equivalent of the state of Indiana so it is a very small portion of the overall economic output of the EU. Even if Greece does go into an economic depression their economic output is very small compared to the rest of Europe. Another reason the managers expect this crisis will be contained is the bond yields for Portugal and Spain are still much lower than those of Greece. Greek sovereign bonds are currently yielding over 10% while Portugal and Spain are between 4% and 5%, if Portugal and Spain were close to a crisis the yields on bonds would be closer to that of Greece. The bigger question over the long run will be to see if the EU can survive this crisis and remain a union.
As we at Cedrus have communicated with you several times in the past, the market trades 6 – 12 months ahead of itself. That means, this Greek debt crisis has been priced into the markets for several months as this comes as no surprise to the managers managing your portfolio. So why has the market gone down so sharply in the last week? The true answer for this is not known for certain but we were at 18 month highs in late April and we are most likely due for a short term correction. The emotions of the Greek problems may have just been the trigger point to start this correction. If you take yourself back 12 months ago you would have been very happy knowing the DOW was going to above 10,500 in May 2010. Even though the market has given up 7% in the last few days, we do not see this as a time to panic.
The managers and SEI both talked at the conference about what they see in the markets and the economy. To many people’s surprise, the US has led the developed world out of the recession. The US had higher GDP growth in the last 12 months than the UK, Europe, Japan, Canada, or any other developed nation. In addition, the US dollar has rebounded tremendously in the last 12 months vs the Euro and should continue to do so for the foreseeable future. The managers also commented on how quickly US corporations took their medicine during the downturn. That means they did the painful task of cutting variable costs such as jobs, manufacturing capacity, etc. This has put corporations in a great place to profit on the rebound of the economy. For the first time in a couple of years we are starting to see top line revenue growth which combined with lower operating costs will boost net income substantially. They still see the US as very well positioned to continue the recovery for 2010 and beyond.
The correction of the last week is a very good example of what emotions can do in a market, especially fear. When the market sold off on Thursday, especially during the artificially exaggerated mid day mistake, panic and fear perpetuated the market. Even traders and investment professionals that have been around the business for years who should know better panicked. In reality, there was little or no reason for the panic that happened on Thursday because it was misinformation that perpetuated the extreme downturn. The Greek crisis is definitely not a reason to panic, but rather a situation to keep an eye on and watch for signs of it spreading. But at this time, neither we nor the managers see any reason for panic. The US economy has poised itself for growth and the US economy is still the driving force in the world.
Please feel free to contact me with any questions or concerns.
-Brandon Ideker
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