The trading math appears simple: Greek deal; buy stocks, sell bonds. No deal; sell stocks, buy bonds. Since Greece’s recent agreement to austerity measures in exchange for more credit, European stocks have rallied more than 7% in three days. Recent gyrations in global markets may be an opportunity to “fade” those moves. Likewise, a liquidity crisis predicated on a Greek exit from the Eurozone might be an attractive investor opportunity, and long-term support of Greece’s flawed policies is likely the opposite.
Greece is a tiny economy, predominantly tourism and service-based, with a supporting robust agricultural sector. In 2008, European banks had more than €300 billion ($325.1 billion) worth of Greek loans, while today they have about €50 billion at a time when the banks themselves are well-capitalized. A Greek problem would not make European banks the vector of contagion from 2008, as those banks have raised some €250 billion of capital since then.
Spain, Portugal, Italy, and Ireland are all finding success in the wake of the imposed EU austerity measures. Ireland has done especially well, growing nearly 5% in GDP last year on the strength of its technology economy. The Irish dovetailed their outstanding University system with global technology needs, building an economic infrastructure that should flourish. Even Greece was showing steady, if unspectacular progress before electing Alexis Tsipras and the ultra-left Syriza party into power earlier this year.
The world did not take Tsipras seriously, having witnessed this pattern previously. In 1981, Andreas Papandreou, a Greek socialist, won the election by railing against the European Economic Community (EEC) and vowing to lead Greece out of NATO. Once elected, he saw his best tactic was to work with NATO and exploit the power of that partnership rather than withdraw. More recently, French President Francois Hollande followed suit, elected as a vehement opponent of EU austerity measures, only to seek further help from the EU once in power. Tsipras turned out to be more difficult; leading his country to default on a €1.55 billion IMF payment, and scheduled a referendum that resulted in Greece’s popular rejection of EU austerity measures.
While the missed payment was not perceived by the markets to have immediate consequences, a missed payment to the European Central Bank (ECB) would be another matter entirely. When the EU and Tsipras struck a deal, the equity markets cheered, but bond markets remained skeptical, and unsure that the Syriza government would adhere to any deal over time.
The bond rationale is simple: government bailouts that artificially buoy flawed economies do not work. Until an economy undertakes the discipline to restructure, the bailouts merely promote the policies that led to the initial difficulties. The uncertainty of the EU associated with a Grexit is temporary. Promotion of structural inefficiencies through what appears to be unlimited credit creates larger issues. Ultimately, the bigger risk is broader political contagion among other nations. The notion of an irrevocable monetary union could give way to nationalistic demands of each member nation, and the Euro would likely collapse. While the current trade is to buy a Greek deal, we believe the better investment is to sell it.