Ryding: U.S. Investors Should Take a Chill Pill Over Greece

It would be better if all the TV screens on the trading floors were switched off over the last 48 hours. That way traders would not have seen riot police, rioters, burning buildings in Athens, etc. These troubling pictures (and the reports of deaths) are very disturbing and feed emotions. However, riots over economic policy changes are far from unknown in Europe and these protests should not sway the Greek government from the needed policy actions to rein in the fiscal deficit. Yes they will have a deep chilling impact on an already weak Greek economy but U.S. investors need to keep the size of the

Greek economy in perspective

Greece has been extended a €110 billion ($140 billion) rescue package co-financed by the nations in the Eurozone and the IMF. The package still has to clear some political hurdles in the German parliament but, just as the market turmoil following Congress voting TARP down on the first pass whipped the House into line, today’s market gyrations should send a clear message to the Bundestag. Hold your noses and vote for it or the fallout will be bad for Germany. With the package, Greece will not have to borrow from the markets in 2010, buying time to implement policy reforms. Greece has lied and cheated on the size of its fiscal mess and now has to pay the piper.

Markets, however, are worried that either the package will not be enough to prevent contagion to Portugal, Ireland, and Spain or that the package will fail to clear the political hurdles in Germany. One lesson from the financial crisis is clear: the longer governments delay to take dramatic action to stem a crisis, the greater the action has to be. The other lesson we learned, however, is that after Lehman, governments will not stand by and allow their banks to fail. It did not help matters that in today’s ECB press conference, President Trichet said that buying government bonds was not discussed at its policy meeting. However, the ECB has relaxed its collateral rules so that Greek bonds remain eligible collateral for ECB operations and the size of the weekly repo operations has been upsized from €75.2 billion last week to €90.3 billion this week (technically the operations are done at a fixed rate of 1% and all demand is met—a history of the operations can be charted on the useful Bloomberg page FLIQ and set the region to Europe). European banks will not, therefore, have liquidity problems on financing Greek or other government bonds at the ECB window. The ECB likes to stick to its price-stability mandate rhetoric but, when it comes down to it, the ECB will act to ensure financial stability.

Greece in Perspective for the U.S

The near 10% plunge in the Dow at one point this afternoon, makes little sense fundamentally. Such a
drop in the market wipes about $1.2 trillion off the value of U.S. equities. Greece’s total GDP in 2009 amounted to $300 billion. Thus, the market fell by roughly four times the value of Greece’s entire GDP! The rebound in the market supports our view that this is a massive overreaction to events in Greece. If the ECB and the European governments stand behind the banks, the fallout on the U.S. economy would be minimal. U.S. exports to Greece in 2009 were (drum roll please) $2.5 billion (yes billion—thus the market drop at its worst today was 1000 times U.S. exports to Greece). Exports to the PIGS in total in 2009 was $19.8 billion.

The U.S. market has been on an almost uninterrupted run higher and was due for a correction. We had signaled less enthusiasm towards stocks two weeks ago as the S&P 500 came within 4% of our target of 1,250 for 2010 and as we have become more concerned about the size of the tax hike on dividends in 2011 (see Taxing Matters II: Dividend Tax Lunacy, April 23rd). In our view, worry over Greece was the catalyst for the correction in the U.S. equity market (although CNBC is reporting, somewhat plausibly, that there was a ‘fat-finger’ trade which resulted in a huge sell order resulting in huge price drops for stocks like Proctor & Gamble, which traded down to as low as $39.37 per share but ended the day at $60.75.

If stocks have overreacted, so have bonds, and we head into the payroll report with 10-year Treasury yields at 3.39%. We expect the report to show a modest increase in private payrolls (50,000) and a slight drop in the unemployment rate (to 9.6% from 9.7%). Oil sold off sharply as the June contract fell $3 to $76.9 per barrel (but the low was $74.6 per barrel today). In contrast, gold rose $32 an ounce, to $1,207 on the June contract. Investors are concerned about the future value of paper money (fiat currency) and a gold rally has been one of our themes for 2010. The markets are likely to be a white knuckle ride for a while longer but we think investors should focus on the fundamentals. The U.S. fiscal outlook is a mess and yields make little fundamental sense at these levels (especially in response to a sovereign debt crisis). The U.S. economy needs jobs not Greece. Tune in at 8:30 tomorrow.

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