FYI | May 21 2012
by Peter Switzer, Switzer Super Report
Believe it or not, there is no legal provision for a country to leave the eurozone despite the Greeks looking like they are searching for the exit door – but the issue is spooking markets. Of course, we have seen this sell in May and go away panic for two years now and since the highs this year, stocks are down over 6% here and it has been bigger overseas.
Regular readers will recall I was expecting a sell-off, but now I have to guess how bad this will be for both my readers and for my own advice, which is to “buy the dips”.
The Greek drama
Let’s look at the Greek drama and its wider implications.
First, the Greeks would have to set a date to exit the eurozone, reintroduce the drachma, reset wages and prices, and adjust to a new exchange rate. There would also be an exodus of money from the banks with euro owners fearing capital loss from the changeover. On Tuesday night, Greeks reportedly took out €700 million from Greek banks.
The lower currency would make a Greek holiday cheaper and so it would be great for business, but inflation would kick-up as the drachma would be a dud currency. European banks would be left holding Greek debt of dubious quality and the European Central Bank (ECB) would no longer buy it. Further, the Wall Street Journal (WSJ) says the ECB would not lend to banks against Greek government debt!
Under international law the debt would have to be redenominated into drachmas and there would be a lot of dramatic negotiations, which would affect the balance sheets of the banks exposed to Greek debt. This is why share prices head south when such uncertainty is in the wings. The WSJ reported Institute of International Finance estimates that the cost of Greece leaving the eurozone could be about €1 trillion! Yep, that’s why stock markets are spooked.
The domino effect
There would be widespread bankruptcies in Greece as businesses would be caught between existing debts in euros and the fact they are earning income in drachmas, which in all likelihood would be under depreciation pressure.
This would compound onto Greek banks which would already be under insolvency pressure but are currently being helped by the ECB. That would end and a real financial crisis could ensue. But this is why stock markets are selling off as the global financial system is so heavily interdependent.
This is only the start of the potential panic because the next fear would be that of contagion where no one trusts the likes of Portugal, Ireland, Spain and Italy, and this would push up bond yields and screw up international lending.
So this is the scary story in a nutshell and it is why European Union (EU) forces will be working hard to come up with a better resolution than one where the Greeks leave the eurozone. Now they might, but the EU has time to be prepared for this and to contain the damage.
Cautiously optimistic
AMP Capital Investors’ Shane Oliver is cautiously optimistic about 2012 compared to the past few years where we saw stocks devastated between May and October.
“The key differences compared to the last two years – where share markets fell by around 15-20% from April/May highs – are a stronger US economy (particularly the housing sector which is looking more and more like it is starting to recover), global monetary easing and cheaper share markets,” he pointed out.
He argues it should limit the downside in shares and help result in much stronger share markets by the end of the year.
Of course, if you followed Warren Buffett, you would not invest when you don’t understand what is going on. On the other hand, he does recommend buying great companies that are solid businesses and to especially buy them when external factors – not internal factors to the company – are driving down share prices.
I am a dip buyer… but not just yet!
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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