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A Greek Tragedy...by Saltus Investment Managers

Posted Thursday, 02 July 2015, 10.07am

Greece – thoughts on the recent news and events

Greece is assuming an importance beyond it’s economic footprint for three important reasons:-

  1. This is just one of several big risk factors in the world all coming to a head at roughly the same time. As well as Greece we have a coming interest rate rise in the USA, which is perhaps the biggest event since the crisis of 2008. We also have a sharply slowing Chinese economy, an aggressive reform programme in Japan with global impact through the currency markets and a worsening geopolitical situation (in Europe and the Middle East).
  2. These risk factors are making headlines at a point when valuations of assets are no longer cheap and some, such as safe haven government bonds, are the most expensive they have ever been.
  3. Europe in aggregate has yet to recover convincingly from the crash of 2008 and if Greece exits then the markets will fret over ‘who is next? – can the whole euro project, supposedly irreversible, fall apart?’

When all of these factors are considered, it is unsurprising that a country with very small interaction economically with Europe and the World is driving risk aversion almost everywhere.

The decision to call a referendum, close banks and impose capital controls has now moved events from ‘smoke filled rooms’ of governments into the street and real peoples lives. That will make things much, much harder to predict as real people will start to feel real pain very quickly as the Greek economy slumps to a halt. The pace at which this happens largely depends on whether the ECB will pull the plug on emergency assistance to Greek banks , who are running out of cash and teetering on the brink of insolvency. The ECB won’t pull the plug until top level politicians allow them to do it, so the ball is really now in the German/French government court. They will wait until the referendum result and react accordingly.

We suspect that the rest of Europe will let the pressure build inside Greece for as long as they can in order to force an agreement. They can do this because the threat of contagion i.e. a region wide panic is containable, in their opinion. The impact is containable because there aren’t many mechanisms through which Greece can impact other economic players ( e.g. no banks or corporates have any direct exposure of note). The ECB also has massive firepower through its QE programme to step in and stabilize markets if needed ( e.g. buying Spanish or Portugese government bonds if they start coming under pressure in a ‘who’s next’ type of game).

Greece’s chances of exit have now risen considerably – to over 50% ( some commentators say up to 85%). If they choose to default on a mid July payback of a loan to the ECB, it is extremely difficult to see how they can avoid moving towards an exit. An EU government defaulting on payments to the EU Central Bank is a big no no in German and everyone else’s eyes. In general, the markets seem to be taking a relatively sanguine view so far (even allowing for a bad month in stocks, the Euro has hardly moved). We think this measured response so far is because:

a. Grexit could allow the EU to proceed to a more balanced union without Greece - one where banks and fiscal polices could be properly integrated and held to German standards. In other words the EU could be stronger without Greece in it. Greece outside the EU would have a difficult few years, but eventually the new drachma and new monetary policy could allow them to find a path to growth quicker than the one they currently face (it’s a lot easier to grow when you aren’t paying your debts !)

b. Or perhaps the markets are relatively sanguine because they believe that a solution will, in the end be found.

Either way the Saltus opinion is:-

  1. Volatility will continue but it is not the type of scenario where we fear a repeat of 2008. Too much policy support exists for that. Movements in markets should be within the normal noisy trading ranges.
  2. Portfolios have c 17% cash in the moment in anticipation of events like this and we would not intend to be re investing until outcomes become clearer to analyse.
  3. This cash and the broad level of diversification in portfolios has helped shield portfolios from the worst of stock market falls. Year to date we are still up c 2% versus FTSE 100 flat and gilts -3%. This month when stocks have fallen c -6% the average portfolios will have fallen c -2%. Not nice to have a negative month but then again -2% isn’t anything we can’t make back.

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