US markets not immune from Greek turmoil
Equities and corporate bonds vulnerable to risk aversión
by: Mohamed El-Erian
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The US government’s public narrative on Greece has evolved in the past week — from “not our problem” to noting that while there is a potential for adverse spillovers, concerns are lessened by financial markets having “properly factored in” the situation.
Yet investors in US securities would be ill-advised to ignore what is likely to occur next in Greece. With the situation there extremely fluid and fragile, investors would do well to prepare for greater market volatility that offers both shorter-term risks and longer-term opportunities.
From a purely economic angle it is correct to downplay the contagion impact of Greece’s horrid economic and financial situation. The country hardly registers in US trade numbers given the small size of its economy and limited interactions.
As such its impending economic depression, while catastrophic for most of its citizens, would not derail the pick-up in US growth; nor would it do so via the US’s linkages with the rest of the eurozone.
The financial angle also appears reassuring. US banks and investors have little exposure to Greece, partly an outcome of the large-scale migration of default risk from private creditors to European taxpayers. This limits the type of financial contagion that proved destabilising in prior crises (be it Lehman’s 2008 collapse, the Latin American debt crisis of the 1980s, the 1994 Mexican Tequila crisis, the 1997-98 Asian crisis or the 1998 Russian default).
But this is not to say investors in US assets are immune from what lies ahead for Greece, including its increasingly tenuous membership of the eurozone.
US equities and corporate bonds are vulnerable to a notable pick-up in overall market risk aversion. That scenario looks likely, at least temporarily, should Greece and its European partners maintain the current path that leads to a disorderly exit from the single currency.
This is an important reason why, behind the scenes, Jack Lew, the US Treasury secretary, held several calls with his Greek and European counterparts. Most recently he urged them to seek a “pragmatic compromise” that involves “further reforms in Greece and a path to debt sustainability”.
Yet such advice seems hard to follow. After unusually acrimonious negotiations, many elements of which spilled over into the public domain in a messy fashion, there is virtually no trust among the negotiating parties; and they draw different conclusions from Sunday’s historic referendum.
Meanwhile the situation on the ground has deteriorated to such an extent as to make the reform and funding requirements even more daunting and, as such, even more difficult to meet.
Washington has urged EU to write off Athens’ debts in return for restructuring, to no avail.
This situation entails both shorter-term risks and longer-term opportunities for investors in US assets.
Initially US asset prices appear vulnerable to heightened volatility, including selling pressure that would accentuate the losses experienced during June. It does not help that financial assets already trade at elevated levels on the back of central bank interventions that have decoupled prices from underlying fundamentals.
A backdrop of limited market liquidity could also force some levered investors to dispose of “winning trades” as they collectively rush for the cash exit.
Yet looking beyond the technical spillovers, US assets still benefit from considerable support over the longer term. As illustrated by last week’s data, economic growth continues to pick up.
The Federal Reserve can be expected to delay tightening monetary policy should significant external disruptions threaten all the hard work it has put in to broaden the US economy’s healing process.
Also there remains a large amount of cash sitting on corporate balance sheets, and that is likely to continue to pour into the markets via higher dividends and bigger stock buybacks, and to spur further M&A activity (whose magnitude in the first half of the year has already exceeded all of 2014).
In sum the potential intensification of the Greek crisis creates an additional set of risks for investors in the short term, offset by the opportunity for attractive entry points down the road.
That also entails patience on the part of investors. Any buying opportunity will take time to develop given the high initial market valuations.
Mohamed El-Erian is chief economic adviser to Allianz and chair of President Barack Obama’s Global Development Council
This version has been updated to reflect the result of the Greek referendum result.
Yet investors in US securities would be ill-advised to ignore what is likely to occur next in Greece. With the situation there extremely fluid and fragile, investors would do well to prepare for greater market volatility that offers both shorter-term risks and longer-term opportunities.
From a purely economic angle it is correct to downplay the contagion impact of Greece’s horrid economic and financial situation. The country hardly registers in US trade numbers given the small size of its economy and limited interactions.
As such its impending economic depression, while catastrophic for most of its citizens, would not derail the pick-up in US growth; nor would it do so via the US’s linkages with the rest of the eurozone.
But this is not to say investors in US assets are immune from what lies ahead for Greece, including its increasingly tenuous membership of the eurozone.
US equities and corporate bonds are vulnerable to a notable pick-up in overall market risk aversion. That scenario looks likely, at least temporarily, should Greece and its European partners maintain the current path that leads to a disorderly exit from the single currency.
This is an important reason why, behind the scenes, Jack Lew, the US Treasury secretary, held several calls with his Greek and European counterparts. Most recently he urged them to seek a “pragmatic compromise” that involves “further reforms in Greece and a path to debt sustainability”.
Yet such advice seems hard to follow. After unusually acrimonious negotiations, many elements of which spilled over into the public domain in a messy fashion, there is virtually no trust among the negotiating parties; and they draw different conclusions from Sunday’s historic referendum.
Meanwhile the situation on the ground has deteriorated to such an extent as to make the reform and funding requirements even more daunting and, as such, even more difficult to meet.
Washington has urged EU to write off Athens’ debts in return for restructuring, to no avail.
This situation entails both shorter-term risks and longer-term opportunities for investors in US assets.
Initially US asset prices appear vulnerable to heightened volatility, including selling pressure that would accentuate the losses experienced during June. It does not help that financial assets already trade at elevated levels on the back of central bank interventions that have decoupled prices from underlying fundamentals.
A backdrop of limited market liquidity could also force some levered investors to dispose of “winning trades” as they collectively rush for the cash exit.
Yet looking beyond the technical spillovers, US assets still benefit from considerable support over the longer term. As illustrated by last week’s data, economic growth continues to pick up.
The Federal Reserve can be expected to delay tightening monetary policy should significant external disruptions threaten all the hard work it has put in to broaden the US economy’s healing process.
Also there remains a large amount of cash sitting on corporate balance sheets, and that is likely to continue to pour into the markets via higher dividends and bigger stock buybacks, and to spur further M&A activity (whose magnitude in the first half of the year has already exceeded all of 2014).
In sum the potential intensification of the Greek crisis creates an additional set of risks for investors in the short term, offset by the opportunity for attractive entry points down the road.
That also entails patience on the part of investors. Any buying opportunity will take time to develop given the high initial market valuations.
Mohamed El-Erian is chief economic adviser to Allianz and chair of President Barack Obama’s Global Development Council
This version has been updated to reflect the result of the Greek referendum result.
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