Sunday, March 25, 2012

After Greece, What Now?

It’s been a tumultuous last few months in the markets. Investor emotions have run high, low, and everywhere in between from the European crisis. Watching with intrigue from the sidelines, I wondered every week when the crisis would end, and when it ended how I would know that it had ended. The trend seemed scripted: the European leaders would put out a plan that would “save” the EU, the stock markets would rally, only for the indexes to be lower within a week.

After an up and down last few months, it seems like the critical stage of the Greek crisis has passed with a steady and ‘successful’ debt restructuring/default, reducing total government debt of €206 billion by about half. In tango with the debt swap, the EU has agreed to release another bailout worth about €130, neatly covering Greece’s debt payments for a long while. Great deal for Greece, horrible for the investors (i.e., European banks, asset management firms). This has also triggered a credit event, meaning that we all get to witness how a credit default swap works (CDS), which are supposed to insure against a default. Exciting stuff.

Is it the end of Greece? In my mind, ‘yes’ both figuratively and literally. Greek debts have been covered temporarily, but it also means there will be tough times ahead for the Greek economy. Previous countries that had defaulted/restructured their debt, like Mexico and Argentina, have taken a long time to crawl back up after getting hit pretty hard.

On a side note, for a long term investor these events have been a learning experience. I for one, had never even heard of terms like Long Term Refinancing Operations (LTRO) or TARGET2, nor had I ever witnessed a country defaulting on their debt and how a credit default swap (CDS) actually worked.
So what’s next? Media has focused on the high crude oil prices ($125), nagging elevated high European government bond yields and the slow-down in China (7.5% GDP growth). All are legitimate concerns which I will talk about:
  • Oil - Having read the news scouring for reasons of the return of the high oil prices, it seems like people largely blame Iran and supply and demand. To me that does sound very plausible, but I’m starting to become inclined to think that it’s the low interest rates that’s inflating the commodity prices. Do I have any facts to back this up? Haven’t looked to be honest, but this rationale of low interest rates inflating assets remains the most logical to me. I mean, why else is gold, a useless commodity as a friend always likes to remind me, priced more than the laptop I’m using to write this blog?
    • More importantly, how significant are high oil prices to the global economy? I believe that the world, having seen oil prices above $140 as recently as 2008, won’t be impacted as much as before. The relative rise in oil prices from $80 to $125 just isn’t as much as from $20 to $140. People aren’t really as shocked as 2008 and the ‘wow’ factor just isn’t there. Not to say that it won’t have an effect in slowing down the economy, but I wouldn’t highlight it as the insurmountable concern in the world.
  • Spanish/Portuguese/Italian bond yields – Yes, yields are elevated, but is the EU prepared to take action in case something drastic happens? Seems like it, yes, so I’m crossing it off my list as something I should worry in my sleep about. Wouldn’t it be cool if I could pick what I dreamt about in my sleep?
  • Slowdown in China – Wait, so the world had to wait until Wen Jiabao to say that the Chinese economy was slowing down to know that the Chinese economy was slowing down? Hope you insinuated my incredulous tone of voice.
So no, I still haven’t answered the title of my post. I haven’t because as opposed to all the complexity of the concerns in the market, my view is relatively simple and one that readers of my previous posts will know. As long as monetary policy is accommodative to growth in the world, which it is as seen by the multitude of central banks that have stopped hiking interest rates or have kept low interest rates, the economy will slowly crawl back up. Maybe not at the rapid speeds seen in the mid 2000’s, but it will chug along. Even with high oil prices, which I have seen many-an-article talk about how they are usually followed by a recession, I don’t see the world economy receding much more. Certainly not unless oil prices rise to above $160, which could certainly spell trouble as that means inflation concerns might trump growth concerns for central banks across the world in the form of rapidly increasing high interest rates.*

* In my mind, the speed of interest rate hikes matters significantly. Shocks are usually not good for the system.

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