Greek Tragedy

Investment Notes

Both we and markets were surprised by the turn of events concerning Greece over the weekend. Our central assumption had been that an agreement would be cobbled together as deadlines began to bite, and we didn’t expect the Greek government to call a referendum; the subsequent sharp fall in European stock markets shows that other investors had a similar view. The question now is whether the reaction in financial markets is simply the volatility that arises when unexpected events occur, or whether there is a risk of a permanent loss of capital. We are taking an optimistic stance, expecting company share prices to recover; we don’t believe that events in Greece will derail the economic recovery in Europe and the West, for the reasons set out in this note. Meanwhile, we are likely to see more tragic scenes from Athens on the television news, as the crisis impacts everyday life.

The announcement by the Greek prime minister of a referendum on the bail-out plan on Sunday 5 July 2015 was clearly a shock to all parties around the negotiating table, and is likely to destroy what little trust was left between them. It has also set Greece on an unpredictable political path. The ruling Syriza party is hoping that a ‘No’ vote on the proposed bail-out conditions will enable them to get a more favourable deal with the IMF and EU, but they are unlikely to be successful; the headlines caused by the precipitous announcement has alerted non-European contributors to the IMF to the possibility of a generous deal for Greece, and taxpayers in other Eurozone countries will be holding their governments to account for any largesse with their money.

Meanwhile, opinion polls in Greece currently indicate that the ‘Yes’ vote is likely to win, with the electorate approving the requirements of the EU, ECB and IMF. Support for Eurozone membership has remained high throughout the turmoil of recent years and if the Greek electorate decide to vote in favour of the referendum (in the rational expectation that it is the best way of retaining the euro as their currency) the coalition Government is likely to fall. What happens then is unclear; the opposition lost last year’s election partly due to a lack of respect for their efforts to control corruption and enforce tax collection, so the electorate is going to find it hard to know who to trust with their future.

The consequences of the referendum announcement are starting to be seen in everyday life in Greece. The introduction of capital controls at the end of June and the subsequent cessation of many banking services may currently only be an inconvenience, but it won’t be long before there are issues with food, fuel and medical supplies. Whether or not these come to the fore in a way to influence the result of the referendum isn’t yet clear, but there remains a strong possibility that the current economic crisis turns into a humanitarian one.

Given all of these uncertainties, how can we be sanguine about the prospect for financial markets? First, the Greek economy only represents 1.3% of EU GDP, therefore a local economic depression is unlikely to derail the developing economic recovery across the continent. Secondly, there appears to be little risk of contagion via the financial sector. The crisis has been developing for so long that international banks have been cutting credit lines to Greek banks for a number of years, leaving them reliant on funding from the ECB, who will surely find a way to absorb losses without disrupting the Eurozone economy. Thirdly, Greece isn’t an important market for quoted companies around the world.

Meanwhile, there is a contagion risk which we are keeping a close eye on, but it is currently political rather than financial. The austerity program in southern Europe not only provoked the creation of the left-wing Syriza party in Greece, but also a similar party called Podemos in Spain. Spain has to hold a general election before the end of 2015, and as the year began, Podemos’ 30% opinion poll ratings made it the most popular political party in the country. The strong Spanish economic recovery (which saw the latest annual GDP growth rate rise to 3.1%) has eased the adverse impact of government cuts and led to a fall in the party’s ratings to below 20%, and third place in the polls. Given the whole situation in Greece, we now believe it is unlikely that the Spanish electorate will mimic that of Greece in voting for an anti-austerity government later in the year, but this is a risk we will be monitoring. Were Podemos to win the Spanish election, the impact would be material, as Spain represents 7.6% of EU GDP, and the economy and financial system is highly integrated with the rest of the Eurozone and world.

The Greek situation has exposed many flaws in the design of the EU and Eurozone, but as has been the case in the development of the single currency bloc in the US, institutions and laws are likely to be developed as lessons are learned from crises. When the history books are written, we expect the chapter on Greece will most likely focus on the length of the crisis, rather than its material impact on the rest of Europe. Meanwhile, our overall investment strategy remains unchanged, as outlined in our recent Investment Update, ‘June: Bloom or Gloom’, which we published a fortnight ago.

To discuss this note or any other matter, please contact Nick Fletcher on 020 3696 6801, or any member of the London Wall Partners investment team on 020 3696 6805.