Stock volatility has picked up this week in response to the breakdown in Greek debt negotiations over the weekend. Because the situation is fluid, any written commentary in this environment can become outdated as quickly as it is published.
Nevertheless, below we offer some key insights on recent developments that will make you the expert at your 4th of July BBQ.
1. Greece isn’t as big a deal as you think.
From a portfolio exposure perspective, Greece makes up just 0.02% of our equity allocation and is 0.08% of overall global market capitalization. From an economic perspective, Greece makes up 2% of the euro area economy and just 0.26% of the overall global economy.
Greece’s minimal impact on portfolio returns or economic growth is the reason that it is covered so little in our materials. Once upon a time, Greek issues had a greater impact on the euro area. As the next point explains, that is no longer the case.
2. The risk of contagion in the euro area is much lower than 2010-2012.
Europe has had years to prepare for the possibility of Greece leaving the eurozone and is now positioned better for it.
The most important development is that Greek debt is no longer held by the private sector outside of Greece. Five years ago when most of their debt was held by highly leveraged banks across Europe, a Greek default was more likely to cause a financial crisis. Now, 80% of Greece’s government debt is held by European institutions, with the European Financial Stability Fund (EFSF) holding the majority.
In addition, stronger and more balanced global growth has allowed Europe to digest Greece’s economic contraction. Also, the European Central Bank (ECB) has stepped in as a lender of last resort and is now flooding the market with liquidity through a quantitative easing program.
All of these developments make it highly unlikely that we see contagion spread to the rest of the European periphery in the long-term. Greece has evolved from Lehman Brothers to RadioShack over the past five years – it’s demise just isn’t as impactful.
3. Greece can ignite volatility despite its small market weight and economic contribution.
Recently we wrote that stock market valuations were relatively high, which makes prices susceptible to volatility. Given this context, the uncertainty and negative sentiment that stems from Greece’s situation may be a good enough excuse for some market participants to take profits.
How much volatility is anybody’s guess. Five and ten percent drops in the stock market happen all of the time. We do feel confident, however, that panic revolving around Greece is unlikely to push the U.S. into recession, which is typically a key ingredient for a more prolonged downturn or bear market.
When it comes to stock investing, there is always something to worry about. It is this uncertainty that allows stocks to provide higher returns in the first place. Volatility is not the enemy – in fact, it works in favor of long-term investors.
4. Wall Street likes catchy phrases related to the crisis du jour.
Wall Street loves catchy phrases or acronyms in referring to current market issues. “Grexit” has been the most popular phrase when describing a Greek exit from the euro.
The newest phrase being thrown around this week is “Greferendum,” which refers to the July 5th referendum where citizens will vote to accept the creditors’ austerity proposals in return for remaining in the eurozone and receiving financial aid from the so-called “Troika,” which at least isn’t a made up word.
The Trioka includes the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF). With these organizations and the Greek’s austerity measures, market strategists have a tendency to reference the “Sword of Damocles.”
I don’t know about you, but I’m getting a little “Gretigued.”
5. Greeks are the ones most likely to feel the pain.
Defaulting on the IMF this week won’t result in Grexit, nor does a “No” vote in the July 5 Greek referendum. The next big date in this saga is July 20 when a €3.5 billion payment to the ECB comes due. At this point, the ECB will have to decide whether or not to continue supporting Greek banks.
The chance of Greece leaving the euro has increased substantially, but the decision will be a political one rather than an economic one.
There are many possible economic outcomes for the Greeks depending on a few key very variables, but the one thing that is certain is that it the Greeks are in for some pain. However, if Greece leaves the euro and prospers, then skeptics of European integration will grow louder.
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This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.