By Rick Pitcairn, CFA®, Chief Investment Officer
July 7, 2015 – As the debt situation in Greece took a surprising turn over the July 4th weekend, we thought it would be a good idea to update you on our view of recent events and how circumstances might evolve over the next few weeks.
We have been monitoring Greece carefully for several years now. The country was at the apex of global market meltdown fears in 2011 and has been on the radar of most market watchers ever since. Earlier this year we proposed three paths this current iteration of the Greek crisis might take:
- Greece stays in the European Union (EU) prompting Spain and Portugal to ask for a similar deal.
- Greece exits the Euro.
- The major parties in the negotiation construct some sort of political postponement that appeases both sides.
We maintain that none of these scenarios poses a serious threat to the slow, but steady momentum of global developed economies or the capital markets that underlie those economies. In short, we do not think the outcome of this crisis, whatever that may be, will create a secular inflection point that ends the impressive bull market we have experienced since 2008.
Our presumption is that the situation will spur greater volatility than we have seen in recent months and may even cause markets to gyrate for a period of weeks. However, we do not think this situation requires major changes to long-term asset allocations, nor is there enough clarity at present to attempt to tactically exploit the situation.
Until the evening of July 5th, we favored the third scenario as the probable outcome; politicians love solutions that let everyone claim victory and put off the real problem solving to a later time. However, the Greek electorate’s overwhelming rejection of the ECB’s latest bailout offer surprised many analysts, myself included, and there is now a much greater probability that Greece may leave the European Union. Interestingly, polls show that the Greek people strongly favor staying in the EU and most likely voted “no” based on assurances from the Socialist Greek Government that a no vote would strengthen the country’s bargaining power, while not hastening expulsion from the EU at the hands of European bankers. Current German opinion seems to disagree with that expectation as the election may have steeled European resolve to put an end to Greece’s endless economic fecklessness.
Margaret Thatcher famously quipped that the problem with socialism is that eventually you run out of other people’s money. Greece may now have arrived at the unhappy end of that road. We feel strongly that the Greek people will suffer much more than global economies if Greece leaves the Euro.
Many of you know that Pitcairn’s involvement with the Wigmore Association gives us unique insight into global markets and geopolitics. Obviously, given the current situation in Greece, we have tapped Wigmore’s collective resources to gain a great deal of knowledge. Our German member told us “there is a quiet confidence in Germany that we could get along just fine without Greece in the Euro.” That idea runs counter to the common perception that a Greek exit will cause the Euro to rise and hurt German exports, which are critical to that country’s economy. The last proposed agreement put forth by the ECB was actually a document of compromise and delay that gave Greece much of what it desired. I am still astounded the Greeks walked away from it. Such is the power of Greece’s political constituency. The irony is that the two sides may not be at all far apart, but neither has even the smallest political wiggle room to move toward the other.
If that is the case, then we must consider the ramifications of Greece exiting the Euro. On Monday morning, I heard a commentator state that a Greek exit from the EU would risk the Union’s credibility because no country has ever left the alliance. In my view, that is a little like saying Harvard expelling a failing student risks the University’s academic credibility. I would strongly disagree and posit that making even more concessions to a reckless debtor nation actually puts the Union’s credibility at greater risk by signaling other debtor nations like Portugal and Spain that their obligations are open to negotiation.
That said, I don’t completely discount a last minute overture to try to keep Greece in the European Union. The miserable state of the populace, banks out of cash and stores out of goods will put a good deal of political and media pressure on the ECB to cave once again. Two questions that will probably be answered within the next few days are whether or not a deal can be resurrected and whether the ECB will extend liquidity assistance to Greek banks so they can reopen. Only with some hope of the first would the lifeline of the second be offered.
We should expect more market volatility as this plays out on a global media stage. The fact that we have not had a substantive market decline since 2011 and the reality that this particular crises rekindles four-year old fears of global financial crises almost guarantee market gyrations. Still, from a financial risk perspective, we live in a much different world than four years ago. Fears of a global financial “contagion” in which Greece’s economic collapse sets off a domino effect in Portugal, Italy, and Spain are vastly overstated. The current buzz phrase for the Greek situation is that it has been “ring fenced,” meaning financial institutions have, by and large, already immunized themselves against this eventuality, as evidenced by current low default spreads of major European banks. That was not the case in 2011.
Though the risk of financial contagion is low, there is a chance that some political contagion might occur and it will be interesting to see whether socialist parties gain ground in upcoming elections in Portugal and Spain.
Improving GDP levels across the developed world will be hampered by the uncertainty surrounding a possible Greek exit, but it is hard to see how a country representing such a small percentage of global GDP could have a real, long-term negative impact on the bigger picture. Applying our academia metaphor to currency trends, kicking the worst student out of class actually raises the average GPA of those who remain, so look for the Euro to rise if Greece leaves. We don’t think the Euro will rebound to the record levels of eight years ago, but it might well return to 120 and, as we pointed out in last quarter’s letter, that would bring positives for US corporate earnings.
Lastly, though we consider it unlikely, this situation may devolve into a prolonged muddle that exerts downward pressure on stocks for a period of a few months, rather than a few weeks. Given such a scenario, it is important to remember that every Pitcairn financial plan and each capital market assumption underlying a plan is constructed with an eye toward occurrences such as this. From time to time, geopolitical events disrupt markets and it can be quite unsettling. Discipline and patience are two traits I see in almost every legendary investor I have been lucky enough to meet and this situation may require us to practice both. Last week, I told the other Wigmore chief investment officers that, in two years’ time, this situation would be nothing but a blip on the long-term chart of stock prices. In spite of yesterday’s election results, I stand by that comment.
The state of affairs in Greece and the reaction from capital markets will be fluid for at least the next few weeks. Rest assured, the entire investment and client service team at Pitcairn will continue to monitor events and re-evaluate our positions to ensure that all portfolios are optimally positioned for long-term success. Please contact me or your Pitcairn representative if you have any further questions about the current geopolitical or market environments. And, as always, everyone at Pitcairn deeply appreciates your support.