Greek Soap Opera Continues to Roil Markets
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Greece to Form New Coalition Government?
2. Greece Still Up Against the Default Wall
3. Is Italy the Next Financial Crisis?
4. Latest G-20 Summit Accomplishes Little
5. Conclusions: More Roller Coaster Markets
Greece to Form New Coalition Government?
I haven’t written in detail about the debt crisis in Greece in a while, but this relatively small country of around 12 million people, with an annual GDP of only apprx. $300 billion, continues to rock the global equity markets on an almost daily basis. Maybe it’s time we take a closer look.
Greece’s embattled Prime Minister, George Papandreou, survived a no-confidence vote early last Saturday but agreed to step down on Sunday to make way for a new multi-party coalition government. This seemed to ease some of the uncertainty that had gripped Europe last week over whether the latest Greek bailout would go forward.
Papandreou offered his resignation in order to form an interim government that would approve Greece’s latest international bailout deal and pave the way for new elections, a grave task for a debt-laden, depressed economy whose deterioration has undermined investor confidence in Eurozone finances.
The vote of confidence capped a week of turmoil in Greek politics that disrupted financial markets around the world and raised fears that Greece was heading for bankruptcy and possibly a forced exit from Europe’s common currency, the euro.
Greek politicians from all parties agreed that Papandreou’s days as the country’s leader were nearing an end. The Prime Minister, in an address to lawmakers before the vote, said he was prepared to form a coalition government, which would in all likelihood require him to step aside. He resigned on Sunday.
Just before the vote of confidence, Papandreou vowed, “I have already contacted the president and tomorrow I will visit him. Straight after the vote of confidence, I will inform him of my intention to proceed with talks with all parties to form a government of broad [acceptance].” The photo below is of Papandreou celebrating his vote of confidence victory.
The quest for a Greek unity government is aimed at avoiding a messy debt default and uncontrolled exit from the euro, a once-unthinkable prospect that loomed large amid last week’s political tumult in Athens. Such a government would be charged with stabilizing the country and securing the badly needed €130 billion ($180 billion) aid package agreed to by European leaders late last month.
In the debate’s final stretch, lawmakers wrangled over how long an interim government should serve. Papandreou’s opponents on the right pressed for a short-term coalition, advocating for new elections by year-end. Papandreou’s party leaders, on the other hand, pressed for the caretaker government to be given four to five months. Papandreou argued that holding new elections immediately "would be a catastrophe," but it is not at all clear why. As this is written, it is still uncertain when new elections may occur in Greece.
Greece Still Up Against the Default Wall
The challenges facing the next government are immense, and the room to maneuver is limited. In the next few weeks, Greece must approve its second international bailout deal, secure a promised €8 billion aid installment under its first bailout program, pass a stringent 2012 budget and negotiate a deal with its private-sector bondholders to take a 50% haircut on the money Greece owes them.
The consequences of a Greek failure would be dire. If Athens can’t achieve a political consensus to carry out its commitments under the bailout plan set forth by the European Union and the International Monetary Fund, it risks being cut off from European funding and pitched into a default on its €355 billion in debt, with untold consequences for the global financial system and the world economy.
The prospect of such a scenario was raised last Monday (Oct. 31) when Papandreou, in a desperate attempt to break out of his political isolation, announced a controversial plan to put Greece’s latest bailout plan to a national referendum. This move tanked world stock markets as most everyone believed that the Greek people would vote down new austerity measures.
As a result, Papandreou quickly abandoned the referendum idea by last Thursday under political pressure in Athens and from other European governments. Though Greece appears to have pulled back from the brink of catastrophe – for now – events over the last week or so have badly shaken confidence in Europe’s ability to get a handle on its debt crisis and to keep other countries, Italy most notably, out of the financial crisis.
It remains to be seen if the political factions in Greece shoot down the plan for a new coalition government, especially now that Papandreou has resigned. If this happens I would expect another plunge in the global equity markets – any day now.
As I have been emphasizing for weeks, the European debt crisis will continue to be a primary driver of the global financial markets, with high volatility in both directions continuing to occur, depending on the latest news from Greece and elsewhere in Europe.
Is Italy the Next Financial Crisis?
We are now hearing more and more warnings that Italy may be the next European country to face a financial crisis. Italy has a national debt of €1.9 trillion ($2.6 trillion) compared to Greece’s €355 billion. The ultimate fear is that Italy might need to ask for a bailout to handle its enormous debt load. That would be simply too expensive for the Eurozone, and could trigger a default that would break up the currency zone and drag down the global economy.
Italy has the eighth largest economy in the world based on GDP and the fourth largest in Europe. Its annual GDP was just over $2 trillion in 2010. This figure does not include a huge underground economy in Italy that is thought to be at least 25% of the official GDP.
For at least a decade, Italy has been getting by with high public debt and low growth without setting off major warning bells. Unlike their government, Italian households save a lot and a majority own their homes. That insulated the country from the real estate crashes and private debt crises that hit other economies, like Greece and Spain, so hard in 2008.
But the past two years’ sovereign debt crisis has changed all that. After Europe was forced to bail out Greece, Ireland and Portugal, investors reviewed their assumptions about how risky government bonds in Europe were. Fearing the worst, many traders started selling their Italian and Spanish bonds in favor of safer ones, mainly from Germany.
The possibility that Italy may need a bailout rises each time its borrowing costs go up. Borrowing rates on 10-year Italian bonds reached a euro-era high near 7% last week. Italy’s new chief central banker, Ignazio Visco, insists that Italy can survive with rates of up to 8%, but the extra cost of borrowing is eroding the savings the government gleans from its austerity measures.
To avert default, Italy’s Prime Minister Silvio Berlusconi has come under intense international pressure to approve and implement measures to balance the budget and spur growth. But infighting has been hindering those efforts. As with Papandreou in Greece, Berlusconi has been asked to step down, which just happened this afternoon.
Italy’s Chamber of Deputies (equivalent of our House of Representatives) voted today on a budget plan that includes new austerity measures to trim the euro region’s second- biggest debt and bring down record borrowing costs. While the measure passed narrowly, Berlusconi failed to muster a majority in the 630-seat Chamber. As a result, a vote of confidence is expected to occur soon, at which point Berlusconi may be ousted as Italy’s prime minister. This could well lead to even more volatility in the markets.
Could Italy be the next domino to fall in Europe? That remains to be seen. What is clear is that if Italy defaults, it would almost certainly spark another worldwide financial crisis that could make 2008 look tame.
On a personal note, Debi and I spent 10 days in Italy in early June to celebrate our 25th wedding anniversary. At that time, there were no visible signs of a brewing financial crisis. The economy seemed vibrant; hotels, stores and restaurants were busy; and tourists were everywhere. But that may be changing soon.
Latest G-20 Summit Accomplished Little
The latest summit of the leaders of the “Group of 20” industrialized economies met last week in Cannes, France but failed to advance a plan to fight the deepening European sovereign-debt crisis. There were hopes that the Germans would relent and allow the European Central Bank to become the lender of last resort for the Eurozone, but that did not materialize.
After the fractious G-20 summit failed to agree on fresh financial help for distressed countries, the markets assumed that the odds of a new recession in Europe had increased. Financial markets fell sharply after the two days of talks in Cannes broke up in disarray, amid concerns that Italy will now replace Greece at the center of Europe’s deepening debt crisis.
There were also hopes that the G-20 would agree to increase International Monetary Fund resources by as much as $250 billion to more than $1 trillion, but disagreements about the wisdom of it, structure, size and contributors to the fund forced world leaders to pass the critical issue on to the next meeting of G-20 finance ministers next February.
About all that was agreed to at the G-20 summit was a plan to have the IMF monitor Italy’s ongoing austerity measures. The G-20 deadlock on the European debt crisis led Britain’s David Cameron to issue one of his starkest warnings about the impact on the UK economy, saying: “Every day the Eurozone crisis continues and every day it is not resolved is a day that has a chilling effect on the rest of the world economy, including the British economy.”
Conclusions: More Roller Coaster Markets
The European debt crisis is worsening. Already Greece, Portugal and Ireland have received bailouts, and Eurozone leaders recently approved another €130 billion ($180 billion) bailout for Greece. Italy and Spain are said to be teetering on the brink of a crisis. Italian and Spanish debts are huge compared to Greece, Portugal and Ireland combined.
Just recently, Eurozone leaders voted to expand the European Financial Stability Facility (EFSF) bailout fund from €450 billion to €1 trillion, but the details on which countries will contribute what amounts are sketchy. Since July, I have argued that the EFSF needed to be at least €2 trillion. Now I’m reading reports that suggest the EFSF needs to be at least €3-4 trillion, or even more if Italy and/or Spain have to be bailed out.
The European debt soap opera has rattled equity markets around the world, especially since late July as the risk of a Greek default has soared. It is now commonplace to see days when the Dow Jones Industrial Average rises or falls 200-300 points or more in a single day. And it’s not unusual to see a 200-300 point up day followed by a 200-300 point down day.
In my July 19 E-Letter, entitled “Why Greece Matters to You and Me,” I warned that the European debt crisis was going to become perhaps the main driver of the US and global stock markets. And well it has. The dramatic increase in market volatility since July has been breathtaking.
The so-called VIX Index (the Chicago Board Options Exchange Market Volatility Index) is a popular measure of the volatility in the S&P 500 Index. Often referred to as the “fear index,” the VIX represents one measure of the markets’ expectation of stock market volatility over the next 30 day period. The VIX is quoted in percentage points and translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, which is then annualized.
Take a look at how the VIX (ie – market volatility) has exploded to the upside over the last several months. The blue line is the VIX; the green line is the S&P 500 Index. While volatility has more than doubled, the S&P 500 Index has gone essentially nowhere. Yet there have been many trading days when the S&P 500 rises or falls by 2-3%!
Investors have been spooked by this kind of volatility and have stampeded out of the stock markets over the last several months. According to the Investment Company Institute, which tracks mutual fund inflows and outflows, over $113 billion has been pulled out of US stock mutual funds in recent months. That’s huge! Most of that money went to money market funds and bond funds, both of which are yielding next to nothing, not to mention that bonds have a lot of risk at this point.
At my company, we hear from investors like these every day. They are either out of the market sitting on the sidelines, or are seriously contemplating getting out of the equity markets. Yet they need a decent return on their investments. So what’s our solution?
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Wishing you profits in these crazy markets,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.