Last week ended on a high note on Friday with the news that Greece and the European Union (EU) finance ministers struck a tentative deal to temporarily extend the expiring Greek bailout program until the end of June. However, this is unlikely the end of difficult negotiations, at times acrimonious, among officials over the terms of the continued aid. As I discuss in my weekly commentary, Greek worries could linger for some time to come.
European assets have performed well recently, as investors are taking comfort from a steadier economy and the tailwind of quantitative easing by the European Central Bank (ECB). But the rally suggests that investors had been discounting an eventual agreement between the new Greek government and its creditors. This view appeared to be validated with the bailout extension, but whether or not this will be sufficient time to address the longer term differences between Greece and its creditors remains an open question.
Prior to the announcement, it was revealed that factions within the German government were prepared to let Greece leave the Eurozone. This hardline stance is partly a function of shifting domestic considerations. As the new anti-euro Alternative for Germany party continues to gain momentum, Chancellor Merkel’s latitude to compromise with the Greek government is increasingly constrained.
While Friday’s news should provide some short-term relief, the issue of Greece’s place in the Eurozone is unlikely to go away. As the bailout negotiations continue, investors should focus on a couple of metrics: bank deposits and government finances. Greece has been bleeding deposits since late last year and is now dependent on the ECB’s emergency liquidity assistance facility. A second problem is a plunge in tax collections as individuals withhold tax payments on hopes for future relief. On a cash basis, ordinary tax revenue before refunds was down 18.4% compared to the prior year, a shortfall of roughly one billion euros. Obviously, the ability to repay Greece’s debts is dependent on the government’s ability to maintain a steady revenue stream.
In short, Greece’s problems will not be solved overnight. What can investors expect going forward? For one, be prepared for more volatility as debt negotiations continue between Greece and its creditors, even though we believe compromises are likely. Still, we like European stocks because extraordinary central bank accommodation is keeping equity markets buoyant. By the same token, we also see good opportunity in Japanese stocks. Our preference for these international markets over the expensive U.S. market continues.