Revenge Of The Drachma?

With Euro-exit saber rattling in Greece, what are the global implications?  

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Reviewed by: Dave Nadig
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Edited by: Dave Nadig

Newly minted Greek Prime Minister gave his first speech ahead of heading into the lion’s den of monetary policy yesterday.  He, as expected, called for concessions from Greek debt holders, mostly the lightening of austerity requirements.  This has many worried Greece is headed for a default, an exit of the euro, or both.

But as Don Luskin from TrendMacro pointed out before the Greek elections that got them into this mess, half of Greece’s $320 billion in debt is held by the troika (the ECB, the EU and the IMF) – institutions capable of (although perhaps not willing) absorbing losses.

That doesn’t mean that a “Grexit” (a rather detestable portmanteau) or a simple default on that debt would be a non-event.  It just means that the immediate impact on the private markets wouldn’t be about absorbing a literal loss but about establishing a new world order.  A post Greek euro would have investors very cautious about euro denominated debt, which could have significant implications for broader European economies.

Opinion about what “should” happen is all over the map.  Here at ETF.com, Chris Brightman from Research Affiliates nearly went so far as to suggest that monetary unions like the euro are inherently a bad thing.  David Kotok of Cumberland Advisors suggests that some level of hand-slapping is necessary or the moral hazard of continued appeasement will create bigger and bigger problems.

And as the G-20 meets this week to resolve the crisis, it’s clear plenty of folks think that Greek exit is far from unthinkable. The U.K. has acknowledged that they have backup plans should the Euro go a country light, and none-other than former Fed Chair Alan Greenspan has said that a Greek exit from the Euro is nearly certain.

As an investor what does this mean?  Well, it continues to make a strong case for hedging out the direct euro exposure of your equities, and certainly any broader collapse of European economies would likely trigger increased investment in dollar and sterling-denominated assets (like equities).  The offset of course is that despite a relatively strong economic picture elsewhere like in the U.S. and the UK, there’s no putting your head in the sand about the increasingly interconnected nature of economics.  U.S. and UK companies would indeed also be hurt by true Lehman-level chaos overseas.

The craziest response, to me, is to go all in on Euro-denominated Greek stocks, say, with the Euronext-listed Lyxor FTSE Athex 20 (GRE FP). Which is of course exactly what some investors are doing:

gre fp

In just the past two weeks, shares outstanding in GRE are up almost 25 percent while the stocks themselves have slid, a pattern we’ve seen globally in all Greek-focused ETFs. On the one hand, I’m glad there are liquid ways to express opinions about global events.  On the other, I have to scratch my head.

Almost any outcome here is bad. If Greek fails to negotiate terms that release it from austerity, it is likely on a path to exiting the Euro, which isn’t going to be good for Greek stocks.  If it succeeds, the moral hazard problem actually further erodes any belief I have in the ECB running a rational and tight ship, and that’s bad too.  Maybe there’s a short term recovery in GRE in that case, but its speculation of the highest order.

Regardless, it’s a definite “grab the popcorn” week for market watchers.

At the time of this writing, the author held no positions in the securities mentioned.  You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.

Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of etf.com. Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.