One thing’s for sure – the market’s Greek to Wall Street.
Greece just stunned the world on July 5th with a resounding vote to reject the Eurozone’s austerity measures. Investors had not priced that decision in – most polls had projected a ‘yes’ edge leading up to it – and the shock’s pretty obvious given that futures are pointing significantly lower while safe havens including US treasuries, the dollar and the yen are in demand. The 1st half of the year may be over, but the light at the end of the tunnel regarding a Greek resolution in time for the 2nd half just flickered out. Here’s our attempt to distill the situation.
The EU’s austerity measures, if imposed, would have brought significant pressure on an already distressed Greek economy. A ‘yes’ vote would have meant that voters accepted the creditors’ demands, and the Tsipras government, while having failed to live up to their promise of ending austerity, would have been able to bow out gracefully given that the people had spoken and they’d done pretty much all they could.
A ‘no’ vote, on the other hand, would provide Greece significant bargaining chips to bring the EU leaders back to the table. An ensuing compromise between the creditors and Greece would then be the logical solution given that if the creditors and the EU pulled the plug, a Greek exit from the monetary union would prove catastrophic for the region, with the potential reversion to the Drachma leading to rapid inflation and expenses way beyond what the Greeks could afford. The outcome would range from a potential humanitarian crisis, a possible entry for new creditors such as Russia and China (leading to geopolitical complications), and a failure to live up to the unified European project and currency. Other countries would line up to exit, market confidence would without a doubt plummet due to the uncertainty, and powerhouses including Germany would certainly not be spared from economic turmoil.
As a result, with the ‘no’ vote in – resoundingly, we should add – Tsipras has now placed the ball in his European counterparts’ court. We hope logic prevails – likely a haircut to the debt while Greece stays in the Eurozone. While the negotiations play out, we only know one thing for certain – investors should brace themselves for unending volatility while either of the two endgames occur: the creditors compromise and markets breathe easy, or Greece exits and pandemonium ensues. In our opinion, it’s a binary outcome – a noted feature of stock markets this year. Given that we’re 6 months into 2015, the tight trading range for the S&P 500 so far defines it all – macro events have overshadowed fundamentals as US (and other worldwide) markets move up and down at any news arising from mainland Europe. The S&P 500 itself was up just 0.2% in the first half – the smallest 1st half gain since 1928, according to CNBC. And even with the negligible move, it’s worth noting that the index is trading at 17.9x the past 12 months earnings, up from 17.1 at the start of the year – and significantly above the 15.7x average for the last 10 years, according to the WSJ. From a forward P/E perspective, it finds itself at 16.4 compared to the past 25 year’s average of 15.7x (data from JP Morgan). Median P/Es find themselves at even more expensive levels. Small caps are providing some solace, as stocks have benefited from the economy’s increasing Main Street strength and lack of currency headwinds; the Russell 2000 index has gained 4.9% compared to the S&P 500’s 0.2%. Nevertheless, all eyes are watching Europe this week. China, to a smaller extent, is taking up the rest of the headlines as investors attempt to dissect the market’s reflection of the underlying economy. As Chinese stocks doubled last year, policy makers let them ride. However, with the correction over the past few weeks, its all hands on deck as regulators figure out how to stop the downturn. We’re definitely bullish on China in the long term, but think it’s best to let this market sort out its rules for now. After all, buying and holding in cruise control – or investing, as we prefer to call it – is difficult if the speed limit keeps changing.
What it means for you: We’ve been talking about a much-needed market cleansing for certain sectors; Greece’s negotiations this week may help catalyze this. Any cash handy will be pretty valuable to buy sectors on the cheap, because fundamentally, we do believe that the US and several parts of the world (including Europe) are worthy of investment. Next week, we’ll be outlining our playbook for the 2nd half. Meanwhile, our hope is that the Eurozone finds a solution to the Greek situation – not only because of the obvious clarity it will bring to markets, but also because until then, the pending Fed interest rate hike remains off the table, and a much-needed normalization in asset prices remains in the distance for weary investors. In effect, our recommendation is to keep an eye on the news and hold steady with your investments as European policy makers define the next turn on Wall Street this week.
