From Optimisim to Panic: A Greek Tragedy

Morris Segall     

Thursday’s roller coaster ride in the stock market, punctuated by a nearly 1000 point drop in the Dow Industrial average before recovering 700 of those points, is culminating a shift from market optimism to outright panic. Since Monday, May 3, the major market averages have declined 6%-7% based on increasing fears of debt defaults in Europe led by the well publicized difficulties in Greece.  After protracted negotiations with its eurozone partners and the International Monetary Fund, a financial “bailout” package for Greece was announced last weekend that would appear to have headed off an imminent debt default.  Prior to the selloff of the last three days, the major market averages had risen on average 9% from the period February 3 to May 3  spurred by improving economic news in the U.S. and confidence in a “bailout” solution to Greece’s debt problems. Investor sentiment was overwhelmingly positive and risk aversion had been replaced by risk assumption. So what went wrong?

First, the Europeans, particularly Germany, horribly botched the Greek bailout and turned a serious dilemma into a full blown crisis. The reluctance of Germany to agree to contribute to a eurozone loan facility for Greece dragged out the process of support and brought Greece to the precipice of default. It allowed market traders and creditors to speculate on a Greek default when the issue should have been put to rest weeks ago.

Second, the draconian spending terms imposed on Greece by its European partners and the IMF apparently did not allow for the response of the Greek people. Reform of Greek finances and reducing its outsized debt must certainly entail large spending cuts by the Greek government. However, a population long dependent on public spending was not going to accept such life changing spending reductions without protest, including demonstrations, riots and strikes. The violent reaction of Greeks to the austerity program approved by its government has upset investors, market analysts and market traders. It has led to questions about the ability of the Greek government to enact the austerity program and thus successfully access the bailout money and avert default.

Third, once again the credit rating agencies have not done their jobs and have added to the current climate of fear by now lowering credit ratings on eurozone countries including Spain and Portugal. Italy may be next. Where were these agencies over the last two years when the balance sheets of these countries became so leveraged?  The credit ratings of these countries should have already been lowered. Reducing them now only adds to the negative speculation.

This “Greek Tragedy” has now led to rampant speculation about possible debt defaults in other eurozone countries, namely Spain, Portugal and Italy. It has refocused attention on the massive sovereign debt levels of the industrialized world, including the U.S. and raised fresh questions on how these debt levels will be reduced or if they can. We believe the events of the last three days have dramatically changed the equity market environment here and abroad. In the short term the panic selling of the last three days will expend itself. It may have done so on Thursday. It is also possible that U.S. equity markets may have seen their highs in this cycle. We are reevaluating our capital market strategies.  A strong employment report for April will help stabilize the equity markets temporarily.  A dissapointing report will accentuate the current market downslide. 

The sovereign debt issues in Western Europe are not going away. They will overhang debt and equity markets until creditors and investors are convinced credible debt reduction fiscal programs are enacted and accepted by the local populations. We will address the intermediate and longer term issues of soverign debt in a more extensive article on our website. For the moment, we believe a forceful international response to the destructive speculation regarding soverign debt defaults in Western Europe is necessary, and quickly, to restore order to the equity and credit markets.

Morris R. Segall, CFA, CIC