Last Sunday, we published a note to clients about ongoing tensions between the European Union (EU) and Greece. News flow continues this weekend following a Greek referendum on financial bailout terms for the indebted country, with Greek voters rejecting the latest aid package. In this Market Thoughts, we discuss key points to be aware of as we enter another week of headlines. Our initial conclusion is that investors should expect some negative initial reaction from riskier asset classes like stocks and high yield bonds. However, Greece’s fate within the EU and, more importantly, Greece’s implications for investors, will not be decided in a day. We encourage clients not to draw any hard conclusions yet.
To recap, Greece owes creditors for years of bailouts resulting from the Greek government’s spending far in excess of revenue. Markets had anticipated that negotiations between Greece and the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission, referred to as the troika, would resolve before the bailout program ended on June 30, the same day Greece owed the IMF 1.6 billion euros. Unfortunately, expectations were not met. Greece decided to hold a public referendum on a European bailout extension after the payment deadline. European leaders, in turn, withdrew their willingness to extend the bailout. After several days of bank closures and limited access to bank deposits, over 60 percent of Greeks indicated they did not want to move forward with the bailout terms. This is a tactical victory for the Greek government in further negotiations.
Without question, today’s referendum's result was a surprise. Even so, as discussed in last week’s Market Thoughts, the capital markets are more prepared for a Greek debt crisis than during prior flare-ups for three reasons: governments are the primary owners of Greek debt, the ECB is much more market responsive, and Greece is a small economy, representing less than 2 percent of EU economic output.
Even though the Greek situation should be contained, this weekend’s vote could set a dangerous precedent for other countries battling heavy debt loads; if you threaten exiting the EU, your negotiating power may increase. Since Germany and other European countries have voiced their desires to keep Greece in the EU, and the EU does not want to trigger a domino effect of other countries leaving, Greece has suddenly improved its bargaining position.
Greece has already defaulted on its IMF payment and still owes several other creditors, including the ECB, to whom it owes a payment of roughly 3.4 billion euros on July 20. We expect the Greeks will ask for concessions on both short- and long-term debt repayments, including debt forgiveness, with their newfound heft. Early reports suggest that Greek and EU leadership will be convening soon for more discussions. Markets will look for progress. The ECB has yet to provide substantive comments on the Greek situation, perhaps saving its voice should market turmoil develop.
As noted last week, we see the capital market environment as being glass half full and view Greek issues as contained, but do not presuppose other investors feel the same. Uncertainties about Greece’s future in the EU and implications for other countries remain elevated. Market reactions this evening show U.S. stock futures down a little over 1.3 percent, with the euro weakening against the dollar. Government bond prices are higher and yields are lower. This is the same pattern seen last Sunday night, and by the end of the week, many of those initial reactions reversed.
In addition to Greece, markets need to digest stock market volatility in China and developments with Puerto Rico’s debt situation. While these are important items to have on your radar, we do not see anything that derails our current read on capital markets and implications for long-term investors. As always, market gyrations can be informative for investors. If you find yourself concerned about market fluctuations, you may want to revisit your risk tolerance or capital market expectations. Investors have been fortunate in the past few years, experiencing few market declines, and those declines have been short and shallow.
Eric J. Freedman
Chief Investment Officer