The markets have spoken. This Greek tragedy will likely end in tears. You have been warned.
The Greek tragedy just keeps on rolling.
Doing the damage yesterday was ratings agency Standard & Poor's (S&P) decision to cut Greece's bond rating to BB+, or to junk status, and on a par with bonds issued by Azerbaijan and Egypt.
Yields on 2-year Greek bonds soared to a stunningly high 15%. S&P also said bondholders may recover only 30% and 50% on their investments if Greece fails to make debt payments, losses that may add up to around €200 billion.
World stock markets took fright, with the FTSE down a big 150 points on Tuesday, or 2.6%, its sharpest daily fall since November last year. In the US, the VIX Index, otherwise known as the fear index, surged 31%, its biggest daily jump since 2008. The Dow slumped over 200 points.
The Future Of The Euro At Stake
Greece is a relatively small country, with a relatively small economy. In 'normal' circumstances, the country would simply devalue its currency. This would have the effect of increasing the competitiveness of the country's export sector, and slowly but surely, a country like Greece would be expected to climb out of its hole and regain at least some level of normality.
But Greece cannot devalue their currency, as they are locked into a monetary union. These are not 'normal' circumstances. The future of the Euro is at stake, as is the economic destiny of Spain, Portugal, Italy and Ireland. Here in the UK, even with our own currency, our huge budget deficit would place massive pressure on gilt rates.
The word contagion is being batted about again, and not without justification.
Markets 1, Greece 0
As of writing, even with the IMF pledging further €10 billion to the bailout, it's hard to imagine how some sort of bond default is unavoidable. As the Bank of England found way back in 1992, you can bet against the markets for only so long. Eventually, the markets, and George Soros, prevailed.
Greek bonds are yielding 15%. The markets have spoken. Some sort of bond default is virtually inevitable, and probably sooner rather than later.
The consequences will likely be felt across the globe, with losses likely in European banks. As we found out to our collective cost in October 2008, it doesn't take too much in the way of losses for highly leveraged banks to face potential liquidity problems.
Stock Markets To Feel The Heat
And if that happens, you can be sure world stock markets will feel the heat. For just over a year we've been on a one-way upwards ride. Even after yesterday's big fall, the FTSE is still up over 60% from its March 2009 lows. It would be entirely possible for the market to give back a significant chunk of those gains in the coming weeks and months. Be prepared.
The Greece problem has been ongoing now for months. In that time, we've seen many false calls, both positively and negatively. But now, everything really is coming to a head. The crisis must be resolved one way or another.
Greece's Options
As I see it, the options are…
1. Greece leaves the monetary union and reverts back to a sharply devalued Drachma. This is unlikely, because it would set an unwanted precedent, and perhaps be the forerunner to the demise of the Euro.
2. In return for agreeing to draconian austerity measures, Greece is bailed out by the European Union (EU) and IMF. Greece remains a social and economic basket case for years. This is probably the best-case scenario, unless you happen to live in Greece.
3. Greece defaults on its bonds. Bondholders, including still weakened European banks, face huge losses. Government bailouts become a very real possibility. Welcome to the Great Credit Crisis, Part II.
I think we'll see a combination of options 2 and 3, whereby bondholders take some of the pain alongside that of the Greek people.
The Old Rules Apply
As for the stock market, the old rules apply. If you own shares in weak, highly indebted, speculative or overvalued companies, you could be in for some pain.
I count banks like Royal Bank of Scotland (LSE: RBS), Barclays (LSE: BARC) and possibly even Lloyds Banking Group (LSE: LLOY) and HSBC (LSE: HSBA) in the indebted and speculative category. If you continue to hold them, don't say you weren't warned of the potential problems.
Personally, I have recently sold the two companies I felt less comfortable holding. Sure, I may miss out on some upside if this turns out to be yet another false alarm, but I'd rather be safe than sorry. This Greek tragedy has the very real ability to be quite painful for us all.
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