The markets were under pressure this morning, and although recent lower openings have resulted in the markets rallying back to unchanged or slightly positive, today may prove to be the beginning of the long awaited consolidation period.
The market has been held up for the most part by expectations that getting a deal done in Greece would solve the raft of problems facing the global economy. Unfortunately, the likelihood of a lasting deal is diminishing with each tick of the clock.
Remember, this deal was supposed to be done six months ago, and was
definitelysupposed to be done by last weekend, yet here we are.
Yesterday, the market found its strength from reports that Greece’s three major parties had endorsed the austerity deal proposed by “the Troika” (ECB, EU, and IMF). These are pretty harsh measures for a Greek economy that is in its fifth year of recession. Quite frankly, after five years, I think you can stop calling it a recession and admit it is a depression.
Some of the key provisions put forth by the Troika include a 22% cut in minimum wage, the elimination of 150,000 public sector jobs over the next three years, and a slashing of pension benefits.
The technocratic Papademos led government agreed to the first two, but stumbled gaining support for the reduction of pension benefits. In fact, the LOAS far-right party, although minority in parliament, was a key supporter of Papademos and austerity, but even its leaders balked at the prospects of slashing pensions.
The problem that should’ve been obvious, but seemed to elude European bureaucrats, is that a country deep in economic depression cannot afford to be slashing spending and expect growth to result. The latest unemployment numbers from Greece indicate that overall joblessness stands at 20.9%, with youth unemployment a staggering 40% plus. Additionally, industrial output in December slumped 11.5% on a year over year basis.
This contraction has resulted in an additional funding gap for Greece in the next year of about €15 billion. This may not seem like a lot, but is actually roughly 7% of GDP. The gap means that the second round €130 billion bailout that the Troika is trying to give to Greece will be insufficient. The number should be closer to €145 billion.
But this simply emphasizes the problem. Paying taxes in Greece has always been more of a hobby than an actual obligation, and receipts are falling dramatically short because of the weakening economy, thus creating the funding gap. It’s basically like trying to get blood from a stone.
You have an economy that is contracting at least 5% per year, and this is likely to get worse if wage growth is substantially negative. You have professionals of every stripe, from doctors to lawyers to graphic artists to engineers emigrating in droves. Take them together and it results in both a severe erosion of the tax base and a dearth of citizens most capable of spurring economic growth. It is, in short, an untenable situation.
Large banks and commercial entities have been running simulations for months on what the potential impacts of a return to the drachma might be. If -- and it is a big if -- Greece could exit the Euro and not cause economic disruption on a continent wide basis, then it is possible for recovery to be engineered in the two to five year time frame rather than the 8 to 10 years it might take if Greece remains in the Euro and fully embraces austerity.
The largest part of the Greek economy is tourism, and with the drachma worth only a tiny fraction of the Euro, Greece could recover just from the influx of tourists seeking a cheap vacation. Of course, keeping the country out of civil war will be a key factor in reviving the tourism industry.
The bottom line is that we are finally at the turning point, the make or break point, for the sovereign debt crisis. The Troika may yet find a way to funnel another few billion euros into the Greek government in order to keep it afloat a few months longer, but the market’s enthusiasm for such action may not be as positive as it has in the recent past.
That being said, had this news come out six months ago, the S&P would’ve been down 2% or more. Instead, as of this writing, the broad market is holding on to losses of about 1%.
There is still a lot of enthusiasm for U.S. equities, and there’s certainly a lot of liquidity sloshing around the system, courtesy of central banks worldwide. So if you need to get involved in the stock market, stick with high quality dividend paying names. We could have a bumpy road over the next several months, and if you must be involved you might as well get paid to do it.
Never forget though that cash is a trade, and with a critical Greek parliament vote on the aforementioned austerity measures scheduled for this weekend, cash may not be a bad place to hang out until there is some resolution one way or the other.
