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grexit or stay in the fold

Investors have long feared that Greece would depart the eurozone. But are the economic Cassandras too pessimistic? By Will Jackson


The country, already blighted by high unemployment and civil unrest, would face a range of additional economic challenges, commentators say, including currency devaluation, rampant inflation and the collapse of its banks. Such an event would be disastrous for investors too, they warn, with the resulting loss of confidence in the global financial system triggering a credit squeeze and a sharp fall in risk assets. Indeed, stock market movements this year have often reflected the consensus view on a ‘Grexit’.

Yet accurately forecasting the full impact of Greece leaving the single currency is impossible and such unprecedented, or uncommon, threats often stoke irrational fears. One example was the ‘Y2K bug’, which prompted concerns in the late ’90s that computer systems would simultaneously crash on 1 Jan, 2000 – plunging developed nations into power cuts and food shortages.

But, when the new millennium arrived, it became clear that pre-emptive actions taken by governments and companies had successfully limited the damage to little more than a few wrongly-dated utility bills.

First of all, the [northerners’] sentiment was: they’re the cheaters – they need to be punished. Now [they] say: ‘They are willing to make changes, so we need to work together to do it’alt=''

Tatjana Greil-Castro
Portfolio manager, Muzinich

Similarly, health scares surrounding the ebola, Sars, bird flu and swine flu viruses have so far failed to produce the cataclysms many people feared. The 2009 H1N1 ‘swine flu’ pandemic, for instance, claimed far fewer lives than initial estimates suggested – thanks in part to extensive vaccination programmes around the world.

So, given the propensity of humans to fear the unknown, and the well-established nature of the problem, are investors exaggerating the risks of a Greek departure?

Back from the brink

Recent events have eased concerns over a near-term Grexit. The formation of a pro-euro Greek coalition in June was followed by European Central Bank (ECB) president Mario Draghi’s July pledge to do “whatever it takes” to preserve the currency. Draghi made good on his promise in September by unveiling Outright Monetary Transactions – the ECB’s unlimited bond buying programme. In the same month, markets were further cheered by the German constitutional court’s ratification of the European Stability Mechanism, and the re-election of a pro-euro government in the Netherlands.

The growing sense of relief among investors could be seen across a range of measures. Ten-year sovereign bond yields in the eurozone periphery declined markedly since June, while the euro strengthened against the dollar from late July (see graphs) and European stocks rallied. Last month’s BofA Merrill Lynch global fund manager survey – a poll of 186 managers running more than $500bn (€390bn) in combined assets – revealed that, for the first time since April 2011, this investor group did not view the European sovereign debt crisis as the biggest macroeconomic “tail risk”.


• Fears that Greece will leave the eurozone have eased, following the election of pro-euro governments, ECB actions, and Germany’s approval of the European Stability Mechanism.
• Investors remain uncertain over what the consequences of a Grexit would be for markets, however, with some expecting a large sell-off and others predicting a relatively short-term effect.

Tatjana Greil-Castro, a portfolio manager at fixed income specialist Muzinich, is among those expecting Greece to remain in the euro. She says her view has not changed throughout the crisis and predicts that, even if anti-austerity party Syriza had won the Greek election, it would have quickly softened its hard- line stance, to secure the country’s future in the single currency.

Leaving the eurozone would likely also mean leaving the EU, she notes – a particularly unattractive prospect for smaller economies. In such a scenario, a country would cease to receive the benefits of EU membership, such as transfer payments and freedom of movement, while at the same time being forced to reconcile its significantly devalued currency with large, euro-denominated debts.

Northerners back down

Greil-Castro is also sceptical that the wealthier eurozone nations will risk undermining confidence in the euro- zone by forcing Greece out. Northern European governments have increasingly sought a more collaborative relationship with Athens, in contrast with their earlier view that Greece should suffer the full consequences of its perceived profligacy. “The northerners have learned that by being too strict, it reinforces the problems,” Greil-Castro says. “First of all, the sentiment was: they’re the cheaters – they need to be punished. But we have moved on from that. Now [the north Europeans] say: ‘They are willing to make changes, and there- fore we need to work together to do it.’”

However, fund selectors are less confident Greece has the means or the willpower to remain in the eurozone. Johannes Maier, head of as- set allocation for funds of funds at Postbank, and Jeroen Vetter, a managing partner at Rotterdam-based wealth manager CapitalGuards, both rate the chances of a Grexit at “50/50”.

Maier says the likelihood of such an event has fallen dramatically over the past year, but that prime minister Antonis Samaras’ previous anti-austerity stance makes him doubtful Greece will fulfil its side of the bargain. “The political answers from Greece have changed over time – first from lying, then to ignoring,” he says. “Now they try a co-operative style. But I’m not sure that they get it right, because they are not able to do it, in my opinion.”

Why was the EU created? It came after the Second World War. So if the euro falls, you go back 70 years in history, and all the work will have been done for nothing

Jeroen Vetter
Managing partner, CapitalGuards

Vetter, meanwhile, says he is not close enough to the decision-making process to make a call either way, and that whether Greece leaves the single currency will ultimately be resolved by what he calls ironically, “the two most reliable [groups of] people in the world” – politicians and central bankers.

Counting the cost


On the short-term impact that a Greek exit might have on investors, opinion is divided. Greil-Castro is wary and forecasts a “huge” sell-off in risk assets. “If you invest in Europe, your base case needs to be that the euro will stay together,” she says.

“If that is not your base case, do not invest in Europe. There would be so much uncertainty. We have tried to run through different scenarios of what it would mean. You very quickly go into so many possibilities, it’s impossible to predict.” The resulting loss of confidence could lead to the eurozone “unravel- ling like a pullover,” she adds.

While Vetter and Maier are less confident that a Grexit can be avoid- ed, they view the potential consequences as less damaging. Indeed, Maier expects that, far from bringing about the demise of the euro, a Greek departure could act as a timely warn- ing to both existing and potential eurozone members that they must stick to their political promises, thereby creating a more robust union.

Maier forecasts that, following a two-week plunge in global equity markets of between 5% and 10%, a relief rally would take place, as investors take a more realistic view on the importance of Greece to the future success of the single currency. “Then the next discussion would be, if there is something like a core eurozone, you should stick to these countries – let’s say Germany, the Nether- lands and France,” Maier adds. “You just take a step back with the integration process and start anew.”

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Similarly, Vetter notes that Greece represents a small fraction of euro- zone GDP (see graph), and – while he is worried about the Greek debt exposure of banks in neighbouring countries, particularly the Balkans – he expects that a Grexit would have a relatively short-term impact on markets. Vetter adds that investors have acted irrationally throughout the crisis, and cites the example of a former CapitalGuards client who last year moved his wealth into three bond funds, to reduce his exposure to the euro, without realising that one strategy had a significant allocation to Irish government debt.

Only the bold…

Such irrational decisions create opportunities for bolder investors. Greil-Castro says Muzinich is slightly overweight the eurozone periphery, and points to a recent disparity between Vodafone and Telefónica debt securities. The telecoms providers have similar exposures to Spain and Italy, but while UK-domiciled Vodafone could borrow at about 1%, Telefónica’s status as a Spanish firm meant its borrowing costs were al- most seven times higher. “Technical pressures” on some investors have forced them to reduce their exposure to the periphery and ignore fundamentals, she adds.

Where Vetter is most concerned, in relation to the eurozone crisis, is the prospect of a full collapse of the single currency – triggered by a country which is “too big to save”, such as Spain or Italy. An event of this magnitude could leave Europeans with more to worry about than the performance of their investments.

“A lot of people tend to forget that the euro is basically a peace currency,” Vetter warns. “If you look back – why was the euro created? It was the next chapter in the EU. Why was the EU created? It came after the Second World War. So if the euro falls, you go back 70 years in history, and all the work will have been done for nothing.”