Apocalypse Not

This well-crafted phrase comes from Jason Trennert of Strategas Research in describing the most recent developments about Greece and its financial situation. I’d like to help you better understand what’s going on there and why I see no significant long-term effects on our markets.

By way of background, on Sunday, 28 June, the European Central Bank (ECB) said it won’t be increasing its aid to Greek banks after the Greek prime minister on Friday called for a voter referendum on 5 July to decide how to respond to requirements set by the country’s creditors. As a result, European bank shares sold off Monday and those regional markets dropped over 3%. Our market sold off in sympathy but, as Fundstrat’s Tom Lee observed, this is a “sideshow” for US investors who “should be encouraged by signs of a stronger US economy.”

Here’s why I agree with Tom’s assessment.

Perspective

Greece’s entire economy is only just slightly larger than Connecticut’s. Greece “contributes” something less than 2% of the entire European Gross Domestic Product. Its entire debt of about $360 billion wouldn’t even be a rounding error in our debt obligations. Specifically, the International Monetary Fund loan that is the current focus for default on Tuesday is $1.6 billion. Wal-Mart does that much revenue about every 30 hours…

Other than Ecuador and Honduras, no other modern countries have defaulted more often than Greece. From Greece’s independence in the 1830s until now, it’s been in default for about half of that time – not a new turn of events for them. It even defaulted on the loan it took to help fight for its independence back then. More recently, it was in default from 1932 until the mid-60s… They’ve had a lot of practice at this stuff.

As Brian Wesbury, chief economist at FirstTrust said, “Greece is not Lehman Brothers. It’s like Detroit. When Detroit defaulted, the US, and even Michigan, survived just fine. Detroit had already wasted the money it had borrowed, and so has Greece. The only thing left is recognizing the loss. That does not damage the economy; it will be absorbed by the IMF, EU, and ECB.”

So why should this tiny economy even be the focus of attention? Ripple effect, aka, contagion…
This is the key to the whole Greek thing. It has little to do with Greece, per se. It’s all about the “what if” of whether other similarly debt-laden weak sisters in the euro zone (Italy, Portugal and Spain) would simply leave the European Monetary Union (EMU), go back to their original currencies and simply inflate their way out of trouble. Based on how the bonds of those three countries are currently trading, it doesn’t look as if the market is concerned about that happening.

However, unlike the US Federal Reserve, the ECB cannot rebalance internally. There is no way for it to automatically redistribute wealth from the stronger economies to the weaker as the Fed does. The ECB can’t dictate monetary policy – they seem to be able to only suggest it. Definitely not a long-term solution.

Investing effect

In spite of all the hype and headlines, there seems to be very little anxiety in the global markets about the Greeks. Mario Draghi, the head of the ECB, has said that it has “enough instruments” to deal with any contagion and will use them. This has little similarity to the concerns of a couple years ago and the sovereign debt issues. For Greek citizens, were they to drop out of the EMU, it would be tough as living standards will likely decline as the Greek drachma is returned. Owing money in euros and being paid in drachmas makes for a bad outcome.

The EMU core members want to maintain the Union and the euro. I believe that what Europe wouldn’t be able to absorb is if it caved to the Greek government, if it let them rollover their debts without insisting on reforms that will help Greece eventually repay its obligations. Further, at some point, it seems to me that in order for the EMU to be all it can be, they must integrate and be willing to do what’s needed to create and adhere to a monetary policy through a central bank. Until then, I think the EMU is a lot like a toothless guard dog.

The impending Greece default is not the first financial crisis, nor the last one – for them or the rest of us. The market road is always a little bumpy so, if you want to reach your financial goals, you need to prudently manage your risk through a broad asset allocation and realize that experiencing an occasional bumpy ride is part of the investing game.

Regardless of how this turns out, it’s getting infinitely more press than it deserves. Any sell-off in US stocks remains as a buying opportunity. It’s to your best interest to maintain your long-term investment strategy using a globally diversified portfolio across asset classes. Taking this approach should be a constant focus, rather than misdirected concerns about a tiny, financially irresponsible country missing a debt payment.
Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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