10-15 Associates

Greece Back on the Front Page – July 2015 Monthly Market Commentary

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By Deborah DeMatteo
Managing Director & Chief Investment Officer

Just when it appeared that the economic overcast in the U.S. was beginning to clear, Greece and its roughly 11 million citizens have dominated the headlines for much of the past month. At just roughly 3% of the size of the US population how is it that they can have such a significant impact on the financial markets around the world? As you may have already assumed Greece all by itself is not the problem. The part they play as a member of the European Union is what makes them a much more significant issue.

It may be helpful to first point out the founding principles and objectives that brought forth a unified Europe. You would have to look back to 1957 with the Treaty of Rome which set the objective for Europe of creating a “common market” to increase economic prosperity and contribute towards “an ever closer union among the people of Europe.” The treaty however, makes no mention of economic and monetary union or the idea of a single currency. Between 1970 and 1989, a period of monetary and economic turbulence, finally led to a 3 stage plan culminating with the creation of a single currency and the European Central Bank. With the signing of the Maastricht Treaty, the European Community was transformed into a full economic and monetary union. The participants adopted a range of macroeconomic criteria that were to be enforced in order to qualify for membership in the Union. It was not until 1999 that the Euro officially traded as a common currency and in January of 2002 became the official coinage of the European Union. In January of 2001, Greece became an adopting member of what today are the 19 member states that form the European Union.

The debt crisis in Greece first came to light in October 2009 when they announced that they had been understating their deficit figures for years. With the global slowdown after the financial crisis in the United States, it was no longer possible to hide what they had hoped to grow out of. Greece was immediately shut out from borrowing from the financial markets and by early 2010 was heading toward bankruptcy. In an effort to avoid a n o t h e r f i n a n c i a l c r i s i s t h e International Monetary Fund, the European Central Bank, and the European Commission issued the first of two international bailouts for Greece totaling approximately $264 billion. Total Greek debt is estimated at $271 billion representing 175% of GDP. In a country with 25% unemployment, the economy continues to shrink. Most of the money from the bailout was used primarily to meet debt obligations and did not make its way into the economy. With the money spent, the economy shrinking, and little hope of recovery the situation become more desperate every day.

With the rest of Europe also in significant debt, the financial strength of the Member States does not exist to provide assistance beyond what they have already done. Germany has already provided over €57 billion in loans as part of the bailout, Italy has contributed €37 billion, and France added almost €43 billion. To date they have already extended the maturities from 15 to 30 years and cut the interest rate to as low as .5% on much of the debt. Reluctance has therefore grown since the first bailout in 2010. Lenders have also watched their debt burden rise amid a very slow economy. In addition to their own struggling economies, they fear the economic realities for their own people in the event of a Greek default.

A default by Greece would have an impact of the financial system on its own. The fear alone could potentially create a liquidity problem for European and U.S. banks questioning the further fallout that may ensue. Most Greek debt is no longer held by the private sector or the banks but sits on the balance sheet of central banks. Lack of private sector exposure would limit the damage to the system immediately but would open investors up to a wide range of questions and concerns: Would other Members also choose to abandon the Euro and go back to an independent monetary system? Is the cost of keeping a united Europe worth the risk of letting Greece go? Will this “experiment” of a united Europe and a single currency ultimately fail, or is this simply growing pains of a relatively new financial system within a centuries old system? Unfortunately for the world, we do not yet know the answer to these questions and it will continue to play out in real time in markets around the world every day.

The good news is that although we need to be aware of these events, as well as many other domestic and international events every day, for now the impact is not economic and more representative of short term volatility in the financial markets. As we put the first half of the year to a close, the markets are largely flat for the year with the S&P 500 up just 1.3% and the Dow negative for the year by 1.1%. We continue to see labor growth, with over 200,000 jobs created again in June. Our economy continues to heal even amid the fears of another looming crisis in Europe and the tensions in the Middle East escalated by lower oil prices. July begins the reporting season once again as companies have to open their books and let us know how things have fared for the first half of the year.

Greece does matter, but it does not mean that it should change our investment strategy. Traders have to adapt to the news daily. Long term investors need to know what influences daily price fluctuations, but I would highly doubt that investors such as Warren Buffett have made any changes to their portfolio this past month based on the headlines out of Europe! It should certainly be an interesting summer for the financial markets.

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