Greek Austerity: What Does It Mean for Investors?

Most asset classes around the world have responded favorably to news that the Greek parliament passed an austerity program over the weekend that is designed to cut spending and lower its debt load in exchange for another huge bailout from the European Union and International Monetary Fund.

Indeed, just before 12 p.m. (EDT) on Monday, the major U.S. equity indices were up about 0.50 percent, while bourses in Europe and

Asia have delivered moderate gains following developments in Athens.
In the UK, bank and commodity stocks led the way up for equities.

Moreover, the euro is climbing against the dollar, while oil futures have also delivered meaningful gains in Monday trading, leading most other commodities higher.

“The markets’ positive reaction is not surprising,” said David Smith, chief investment officer at Rockland Trust in Rockland, Mass.

“However, it may just be a short-term phenomenon. In a few days, we may see a negative spin coming out of the Athens vote, which may lead to a retracement in global markets.”

Lawrence M. Glazer, Managing Partner at Mayflower Advisors in Boston said he thinks that global stock markets are trying to look beyond Greece.

“Investors are desperate for good news and recognizing that central banks around the world are pumping liquidity into the markets to cushion against any shock, ahead of many global elections,” he said.

“This is bullish for the stock markets for the near term. Many investors are skeptical that once the enthusiasm wears off, the execution of the austerity programs will be messy.”

Diego Iscaro, an economist at IHS Global Insight in London, commented: “[The] markets’ positive reaction was mainly triggered by the fact that a ‘disorderly’ default in March [by Greece] now looks less probable.”

Thus, while a great deal of uncertainty exists over Greece’s ability (and desire) to actually implement the tough reforms it has promised, it appears that investors around the world may be somewhat optimistic that the Euro zone crisis cannot get any worse.

Of course, we are still a long way away from resolution to the Greek malaise -- indeed, the German finance ministry has suggested that it may not even approve the next bailout tranche unless it receives strict assurances and guarantees that Athens will swallow the bitter medicine it needs in order to get its financial house in order. Indeed, the German finance minister, Wolfgang Schaeuble, told the German newspaper Welt am Sonntag that Greece’s promises regarding austerity measures are no longer sufficient since Athens has broken similar vows in the past.

European finance ministers are also demanding immediate spending cuts totaling hundreds of billions of euros before any more money is forthcoming to Greece.

Iscaro noted that the question now is whether Greece will be able to implement not only the austerity measures, but also the structural reforms its economy badly needs if it wants to stay in the Euro zone.

“Unfortunately, a weak institutional framework and a plummeting economy mean that results on the implementation front are unlikely to improve from their disappointing past record,” he said.

However, Smith of Rockland Trust said he thinks this time is different from previous episodes where the Greek government received large financial rescue packages from the EU and then failed to bring about the necessary reforms.

“The Greeks are now under extreme pressure to meet financial targets and reduce their debt load,” he said.

“EU officials and especially Germany have mandated Greece abide by the terms of the latest bailout. Athens really has no other alternative now -- all the funding will go away if they don’t come through. They know that if they fail, they will be forced into default, which would probably be the worst possible outcome for everyone involved.”

However, Smith believes the chances of such a default are very slim now.

“The risk of meltdown is now very low, and that is what investors, especially in the U.S., were afraid of last year,” he said.

“But after all the measures that European officials have taken with Greece, the chances of either contagion or default have lessened considerably. There is some clarity now and I think investors, particularly in the U.S., are aware of this.”

Indeed, the U.S. and European stock markets have been in rally mode since early October. For example, since Oct,. 3, 2011, the S&P 500 index has jumped more than 22 percent.

Other analysts are also encouraged by equities.

Laszlo Birinyi, president of Birinyi Associates Inc. of Westport, Conn., told Bloomberg TV: “We still think you should buy stocks. It's a continuation of the bull market and we're encouraged by what we are seeing in Europe. I look at the markets, I find they are strong.

There's real buying going on. This is not short-covering or a temporary or transitory thing.”

Smith added that U.S. Treasuries, which are regarded as about the safest investments in the world, doesn’t make sense now for investors.

“With a 10-year yield under 2 percent, and worries that inflation may breach the 2 percent barrier this year, owning these securities would involve an erosion of value,” he said.

However, Bob Phillips, managing partner at Spectrum Management Group, believes in US treasuries as a safe-haven investment.

I think U.S. Treasuries will be deemed the ‘safe investment’ longer term if the Euro zone crisis continues,” he said.
“If [the crisis] continues it will throw the world into recession and the dollar will be the safe haven. The dollar investment of choice as a safe haven holding place will be Treasuries.”

Still, given that gold, U.S. bonds and the U.S. dollar remain safe havens during times of uncertainty, they cannot be ignored.

“I see no reason why this [scenario] would not continue given the depth and liquidity of the U.S. market, and the relatively brighter U.S. outlook,:” said IHS Global Insight US economist Gregory Daco.

Michael Yoshikami, president of YCMNET Advisors in Walnut Creek, Cal., said: “We believe that an investment strategy that includes gold and a healthy measure of more risk-proof assets makes sense in today's volatile world. On the short-term the U.S. dollar may provide a safe haven and particularly U.S. treasuries. But understand that the U.S. economy itself has major issues and we expect some pressure on the dollar on the long term.”

Glazer added that with the recent agreement in Greece, the risk sectors that performed poorly last year are back in vogue.

“Gold has been a safety trade and remains a good hedge against disaster in the financial systems. The agreements in Greece reduce the likelihood of a financial collapse and would be viewed as negative for gold.”

Phillips is less than enamored with gold, though.

“If the world goes into recession I don’t think gold will retain its current price,” Phillips said.

“Gold will perform better if the Euro holds together and they keep Greece in the system for the time being. I think this is so because the Euro holding together combined with the world [avoding] recession suggests inflation will come back given all the money the ECB and Federal Reserve have printed. If we are in recession that money doesn’t go into motion and inflation stays low and gold goes down. If we stay out of recession the odds of inflation will stay high and gold will be the investors’ hedge, thus keeping the price up.

One of the ironies surrounding the Greek crisis has to do with the fact that increased austerity will further weaken the Greek economy, which may already be at risk of slipping into recession -- which, in turn, would make it harder for Athens to pay down its exorbitant debts.

Still, most analysts concur that the Greeks will have to take this bitter pill for a few years in order to avoid a complete default, which is regarded as a far deadlier outcome.

In any case, Greece is trapped, it has no easy way out of this predicament – and how Athens deals with the crisis, will directly impact the larger, more powerful economies of Western Europe and perhaps even overseas,.

Western Europe has likely run out of patience with the Greeks.

“It's clear that Germany does have a limit in terms of its patience and willingness to bail out countries that have not acted responsibly,” said Yoshikami.

“For that reason, one must take a wait-and-see attitude to see if Greece will actually [enact] the reforms as promised. If in fact they do not, I expect Greece at that point to leave the euro zone.”

Similarly, Iscaro of IHS Global indicated that we are now seeing signs of ‘bailout fatigue’ from major western European governments.
“Creditor countries are particularly frustrated with Greece as a result of its clear failure to deliver on the promises made in return of financial help,” he said.

“In our view, the ‘troika’ [EU/IMF/ECB] is likely to be as flexible as possible with Greece given that the contagion effects of a Greek ‘hard’ default are difficult to predict, although there is a perception that the contagion risks have eased following the ECB’s decision to offer cheap liquidity to Euro zone banks. Should the ‘troika’ decide to not to approve the second bailout – or withhold funds at a later stage as a result of a Greek failure to implement – there is a high chance of a Greek euro exit.”