In recent commentary, I suggested that the inability for Greece to repay its debts can still have an adverse impact on stocks. Not everyone agrees with my assessment. Most in the media maintain that the euro-zone has already inoculated itself from the threat of a “Grexit.” Similarly, anonymous comments underneath my previous article(s) jokingly refer to my concern as “stuck in 2011.”
Someone should have told the equity markets in Europe as well as the United States. Shortly after the International Monetary Fund (IMF) announced that Greece would not be making its $300 million euro repayment tomorrow, Friday, stocks around the globe plummeted to session lows. The S&P 500 extended modest losses to nearly a full percentage point, even with the knowledge that Greece now can bundle its monthly debt into a single payment of $1.5 billion euros on June 30. (Perhaps there is growing concern that the beleaguered euro-zone member will formally default at the end of the month.)
Again, the 44th economy in the world is not exactly critical on the world stage. The reason that Greece still matters, however, is that financial chaos there could strike a dagger in the heart of the euro-dollar’s integrity as well as cast doubt on the basis for the euro-zone’s existence. The peripheral countries that had been showing signs of stability lately – Spain, Portugal, Italy – could see their bond yields leap back up to unsustainable levels for the repayment of interest.
It would be foolish to assume that any default by Greece or any exit by the country from the euro-zone in 2015 could only proceed in an orderly manner. Didn’t the Federal Reserve and U.S. leaders believe that the bankruptcy of Lehman Brothers in 2008 would be well contained? As it turned out, there were ripple effects clear across the financial landscape, from the adverse impact on the insurance giant, American International Group (AIG), to the decimation of the value of the Morgan Stanleys and Merrill Lynches in the brokerage universe. More recently, the monstrous moves higher in sovereign debt yields demonstrate how bond market liquidity has dried up ever since central banks began gobbling up that debt in “quantitative easing” exercises. Few can say that they completely know what will happen as a result of limited liquidity in bond trading. In truth, there is no sure-fire way to know how stocks, bonds, currencies or commodities would respond to a formal default by Greece or an exit from the euro block.
Would a disorderly exit by Greece from the euro-zone really be a non-event? Doubtful. European and U.S. market-based securities would likely struggle. Right now, Greek stocks in the Global X FTSE Greece 20 (GREK) may be well off 2015 lows, but they are ultimately flat for the year; they dropped 5% halfway through today’s session, simply because they are now bundling their payment to the IMF for the end of the month. What will happen to assets around the world if they miss the June 30 payment date as well?
Then there’s the biggest unknown of them all: If Greece leaves or is forced out, who might be next? Probably Spain. Maybe Portugal or Italy.
Granted, a Spanish 10-year at 2.15% today is certainly sustainable, even for a country that has struggled to grow its economy. And we are a far cry from the crisis months of 2011, when Spain watched 10-year yields waffle between 6% and 7%. On the other hand, Spanish bond yields have risen from 1.15% to 2.15% in less than three months. If the U.S. economy would struggle with a 10-year above 3%, and it almost assuredly would, how much higher could yields in Spain climb before the euro-zone nation fell back into a recession or modern-day depression? How long before the Eurpean Central Bank (ECB) and International Monetary Fund (IMF) are negotiating with a new Spanish government?
An orderly Greek exit? Yes, that might be an inconvenience, even a net positive. A frantic scramble? Too-big-to-fail countries on the world scene like Spain and Italy could be next in line for calamitous consequences. Notice the similarity in year-to-date performance by GREK and by the iShares MSCI Spain ETF (EWP).
It is true that Greece is at least as likely to buy more time as it is to become the first nation to leave the euro currency. It’s also true that the initial anxiety of a “Grexit” could subside relatively quickly, as the unknown transitions to a known; a correction could serve up a buying opportunity. Yet those who bought the dot-com dips in 2000 and 2001 found themselves throwing good money after bad; those who followed the likes of bank cheerleader Dick Bove or superstar fund manager Bill Miller into buying “financials” in 2008 learned a harsh lesson about purchasing without a parachute. In sum, Greece is like a subprime mortgage that may or may not become contagious.