Greek Debt Crisis: What it Means for You

Investment markets around the world have grown increasingly volatile recently because Greece has, thus far, failed to secure help to pay its national debt, raising questions about the future of the Eurozone, the health of European banks and what the crisis could mean globally.

Normal commerce has now become impossible in Greece.  Small businesses, lacking use of credit cards or money from bank accounts, are left to rely on cash coming from diminishing purchases from customers.  But Greeks are holding on tight to what they have. And suppliers are demanding that businesses pay cash up front.

The Greek government had been negotiating a new agreement that would have delivered financial assistance to help the country pay its debts in exchange for fiscal and structural reforms, but was unable to come to terms with the International Monetary Fund (IMF), European Commission (EC) and European Central Bank (ECB), known as “the Troika”.

However, the emboldened Greek parliament, after having “won” Sunday’s referendum “No” vote to accept initial terms, is having difficulty coming to terms with the need to accept reform in return for a debt write-down.

With their country struggling to stave off financial collapse, Greek officials have restarted talks with skeptical creditors on a new rescue deal, showing up Tuesday without the concrete proposals their European counterparts had demanded.  Then, following that up Wednesday morning with a written submission for a new support program from Europe’s bailout fund…so far only producing an outline of economic measures it would take in exchange for loans.

At this pace, the process is likely to be prolonged.

However, without a deal, Greece’s banks could go bust within days, the first step in the country’s potential exit, aka “Grexit”, from the euro currency union.  Its banks won’t reopen until Thursday at the earliest after the European Central Bank refused to increase assistance.

This is not the likely scenario Greece is ultimately aiming towards.

Volatility is the Only Certainty Ahead

The following Viewpoints on the Greek Debt Crisis are provided by Fidelity’s Portfolio Management Team:

Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation.

1. Will Greece leave the eurozone?

I think this remains a low-probability scenario.  No one wants Greece to leave the eurozone: not the majority of Greek politicians, not the Germans and, according to one recent survey, not the Greek people.  I think that eventually cooler heads will prevail.

2. Could a default in Greece cause ripple effects?

The big question investors have to face is if the events in Greece could be systemic – meaning, could a default or Greek exit from the eurozone cause a crisis in the global banking system or have an impact on the fundamentals in Europe or the U.S.?  Even with increasing uncertainty about the direction of Greece, I think the answer is no.

When this problem flared up in 2011 and 2012, the risk was systemic, because banking systems and sovereign governments in Europe were already on shaky ground in the wake of the financial crisis.  At that time many banks and sovereigns were dealing with bad assets on their balance sheets. European banks, private sector investors and pensions owned Greek debt, and would have taken losses in the event of a default, which could have added to the stress and led to a financial crisis.  But since 2012, more than 80% of Greece’s sovereign debt has been moved to the IMF, ECB and Europe’s first bailout fund, the European Financial Stability Fund.  So even in the event of a default, banks won’t take losses, and capital ratios will not be affected directly by Greece, allowing banks to keep lending.

The other important removal of systemic risk is the ECB’s bond-buying program and the emergency liquidity assistance it makes available to European banks.  This greatly reduces the risk of contagion in other peripheral European countries.

3. What should investors keep in mind?

Ultimately, the uncertainty regarding Greece could drag out for weeks, and that could create volatility in the bond, stock and currency markets.  But there are important firewalls in place to prevent the impact of events in Greece from spreading to other markets.  So it is important to take the long view here and avoid being whipsawed by short-term events.

Dirk Hofschire is SVP of Asset Allocation Research.  His group is responsible for conducting economic, fundamental, and quantitative research to develop dynamic asset allocation recommendations for the Asset Allocation Division of Fidelity Asset Management.

The big picture: Unless Greek leaders drop the referendum idea and return to the negotiating table, it is very unlikely that this affair is going to be resolved quickly and cleanly.  That means we are in a period of uncertainty that may not clear up for weeks.

The good news is that this may have a much more limited impact on Europe and global financial markets than it might have three or five years ago.  The impact of a default now should be more limited, the ECB has liquidity programs and other tools available to help soothe markets during this period of tumult, and the eurozone economy is much better now than at any point since the financial crisis.

During a similar crisis a few years ago, yields on ten-year sovereign bonds in the periphery of Europe rose above 7% in Spain, Italy and Portugal.  Today those bonds have yields around or below 3%, and they haven’t spiked up, even as Greece’s bond yields have risen dramatically.  That shows investors have much more confidence in the ECB and policymakers, the improved economic position of Europe and the more limited exposure of Europe to Greek bonds, loans and other assets.  So there is much less risk of contagion.

The bad news is that this crisis has introduced a huge amount of uncertainty, just as Europe’s economy has gained significant traction.  Even if Greece were to leave the eurozone, it would not be devastating, and it doesn’t mean another European financial crisis; still, volatility and uncertainty could bleed back into business confidence and could stall some of the economic progress we expected.  The riskier areas of the asset markets, such as stocks, are clearly getting hit in the near term due to increased investor uncertainty.  Still, I feel confident that the European business cycle can eventually get better and provide a reasonably attractive backdrop for investors over the next 12 to 18 months.

In the U.S., the economic outlook is even less dependent on the outcome in Greece.  The biggest and best-performing part of the U.S. economy is the domestic side, which is benefiting from improvements in employment and a healthier consumer.  If you think about the parts of the U.S. economy that are not doing as well – exports, manufacturing, investments in energy and multinationals – they all are being held back by the stronger dollar and weak global growth.  So, Greece is a complicating factor in a global environment that is already not helpful to the U.S., and investors should expect more volatility as the year goes along.  But Greece should not change the overall outlook for the U.S., which I still believe should remain in a mid-cycle expansion, which favors risk assets, including stocks.

Implications of “Grexit” on Your Portfolio

Perhaps the most important factor in formulating your investment plan is your risk tolerance; this is the amount of risk you’re willing to assume in order to achieve your most important objectives.  More precisely, your risk tolerance is based on the your financial and emotional ability to withstand negative returns on your investment portfolio.  Before embarking on any investment strategy it is important to know your risk tolerance to ensure that you select the right kind of investments and you are able to set clear objectives.  More importantly, when your investments are aligned with the proper risk-reward continuum, you’re assured many more restful nights.  So, how do you go about determining your risk tolerance?

Look at Your Time Horizon

The most important determinant is time; this refers how much time you have before you will need to access the money being invested.  Younger people, those with more than 30 years before retirement, are more able to withstand the swings and the cycles of the stock market because of the tendency for the market to (ideally) increase over time.  When the stock market declines by 20% or more in one year, as it has done a few times over the last couple of decades, a younger investor, ideally, has the time to allow the market to recoup its losses and forge ahead for a couple of years.  Therefore, a younger investor could potentially take a more aggressive posture towards investing by increasing their exposure to stocks.

An older investor with less than 15 years before retirement has less time, and therefore, fewer opportunities for the market to recover from multiple down years or extreme volatility.  While it is still important for investors in the pre-retirement phase of life to maintain a growth orientation on their investments, their portfolios need to be stabilized with investments that produce less volatile, or more predictable returns.

Impact on Your Current Financial Situation

Using the example of a stock market decline of 20%, you need to ask yourself, if I lost 20% of my wealth this year, would it materially change my financial position?  Moreover, whether your current financial position, based on the amount of wealth you have, your income, and your time horizon, could absorb the loss and still allow you to achieve your long-term financial goals.

Different people have different advantages working in their favour, for example a younger investor typically has more time; a high earning investor typically has excess cash flow to invest; a high net worth investor typically has assets that can be rebalanced.  The answer to the question of a 20% loss in these 3 situations might be that such a loss would not materially affect their financial position.  If all of their money was invested in the stock market, they may be able to withstand the loss and live to see future positive returns.

For an older investor, or one with minimal assets or cash flow capacity, the impact could be more significant.  If they could not withstand the 20% loss, their investment portfolio would need to consist of investments with limited downside risk and limited upside return potential, such as bonds or fixed yield investments.  By allocating a larger percentage of their portfolio to more stable investments, they are not likely to experience such a big decline in the overall value of their portfolio.

Digging Deeper for Answers

You need to ask yourself some serious questions to gauge your general attitude about risk; for instance, when you make decision about your money, such as making an investment, borrowing money, or making a big purchase, do usually feel a) anxious, b) satisfied, c) hopeful, or d) invigorated?  Or, how would you describe your pursuit of your life’s dreams: a) cautious, b) measured, c) strategic, or d) fearless?  Generally, your answers will correlate with your tolerance for risk, from risk adverse to highly risk tolerant.

Finally, your response to loss may be the most telling indicator of your tolerance for risk.  Using the stock market crash of 2008 as a recent point of reference, your response, either hypothetically or in reality based on your actual response, may say the most about your risk tolerance going forward.  During the stock market crash of 2008 did you (or would you have) a) cash out all of your equities, b) reduce your equity exposure substantially, c) hold firm to most of your equity positions, or d) start adding to your equity positions?

It is very important to be mindful of the fact that your risk tolerance may evolve over time.  This personal assessment should be conducted periodically to ensure that your current asset allocation reflects both your emotional and financial ability to tolerate risk.

Sources: Associated Press, Fidelity Investments, Advisor Websites

Nathan Parkhouse is now a Portfolio Manager!

We at Parkhouse Financial pride ourselves on continually enhancing our professional education and service offerings to provide a better overall client experience when it comes to the guardianship of our clients’ investments.

After several years of additional training, I am now registered as a Portfolio Manager in addition to continuing to be licensed as an Investment Advisor.

Clients of Parkhouse Financial now have the opportunity for discretionary portfolio management of their accounts, comprised of the following:

• Model portfolios custom designed to enhance returns and reduce risk
• Access to a broad range of securities including but not limited to stocks, ETFs (Exchange Traded Funds) and managed portfolios
• Tax deductibility of fees for non-registered (taxable) accounts

Contact me directly at 416.838.3617 or nparkhouse@pssecurities.ca to discuss how this level of service could be an ideal fit for the management of your investment accounts.

Sincerely,
Nathan