How’s My Crystal Ball?

Prediction is dangerous, especially when it involves the future.”

Yogi Berra                                   

Greece appears to be moving steadily toward implementation of the brutal terms imposed by the troika (EU, ECB, and IMF) as conditions for the provision of more liquidity to Greek banks and a new ESM loan to the government. There can always be further twists and turns to the Greek tragedy, but we’ve come far enough to assess the accuracy of my prior predictions in this blog. By my count, I got one of my three predictions mostly wrong, and a second correct in principle but wrong on magnitude. Here’s my scoring:

1) Who’s on First? I thought Greece’s new Syriza leadership (Prime Minister Tsipras and Finance Minister Varoufakis) entirely misunderstood the strength of their negotiating position. When you are going hat-in-hand to someone to whom you have previously lied when borrowing money, in order to borrow more money you simply must have in order to survive, you cannot possibly expect to dictate terms. Germany’s Angela Merkel was the key player on the other side, and she was never going to make any deal that would leave her constituents paying indefinitely for Greeks to enjoy better public-sector benefits than they themselves received. Score this one correct.

2) Outside looking in. I predicted that Greek hubris and miscalculation would place them outside the Euro by midsummer. I missed this one on two grounds. First, I underestimated the utter determination of much of the Eurozone to keep Greece in, despite the endless provocations of Tsipras and company. Second, I did not anticipate the ultimate complete surrender to austerity by Tsipras. While we can’t entirely discount the possibility of Tsipras and company snatching even-worse-defeat from the jaws of defeat, I score this one wrong.

3) Buy on the cannons. My final prediction was that significant market dislocation attendant on a Grexit would provide a buying opportunity for European equities, followed by a strong rally. I’ll score this one both semi-correct and unresolved. European markets declined but did not crash, making a low on July 8, then rallied a bit more than 6%. We’ll have to wait and see where European stocks go in the coming years, compared to U.S. equities.

There is one poorly understood aspect of the Greek drama I got substantially correct. The central problem for Europe was keeping Greece within the Euro while simultaneously discouraging the growth of anti-austerity parties in other Eurozone nations. Greece’s comprehensive failure to improve its position by electing a radical-Left government has been noted in other countries, such as Spain, where anti-austerity party Podemos has been losing support.

A quick aside. One of Warren Buffett’s fundamental principles of investing is that we are much better at understanding today’s values than we are at predicting tomorrow’s outcomes. In this respect, it is worth pointing out that my commentary on Europe’s crisis is intended to provide context for understanding our investment strategy, which remains entirely driven by relative prices and relative yields, and not by predictions–mine or anyone else’s.

The Greek Tragedy: Final Act?

As it has been for more than a century, Greece is a financial mess. Last weekend, negotiations broke down between Greek Prime Minister Alex Tsipras and the “troika” of the European Union, European Central Bank, and the International Monetary Fund. (EU, ECB, IMF from this point forward.)  There will be no third bailout for Greece, at least not until the results of Sunday’s Greek referendum are in.

This past Monday, June 29, world stock markets fell sharply. The S&P 500 Stock Index was down 2.1%, erasing all year-to-date gains. This was the biggest decline since April of 2014. On Tuesday evening, Greece officially defaulted on a 1.6 billion Euro loan owed to the IMF.

We have watched the Greek situation carefully for years, and have written about it several times, most recently here. There are two dimensions to this latest chapter in the Greek tragedy.

The first is the human dimension. A Greek exit from the Euro (and probably from the EU as well) is likely to have profound and even catastrophic human costs. The Greek people, most of them hard-working and honest, will suffer greatly. Within a year or two, Greece is likely to be the world’s only formerly developed nation. We may see in Greece a level of poverty, suffering, and social breakdown not seen in Europe in peacetime since the grim decades of the 1920s and 1930s.

The second dimension is financial. How will the Greek drama impact the finances of U.S. investors? This is a very different picture. In the medium term, we expect a “Grexit” from the Eurozone to be a net positive for investors, for several reasons:

  • The risk of a systemic breakdown, like the 2008-2009 financial panic, is low. When the Greek crisis emerged in 2009, European banks had dangerous exposure to Greek loans, and a default could have triggered a collapse of Europe’s financial sector. Those big bank debts have been written down and recycled to European governments. If Greece defaults, it will cost European taxpayers billions, but we see little risk of contagion.
  • Monday’s market action was not unusual. Historically, declines of 2% or more happen several times a year. (Back in 2008-2009, they often happened several times a week.) Here in the later stages of a long, long bull market, periodic downside surprises are inevitable. What has been unusual is the very low volatility of markets since 2013. Expect a bumpier ride, but don’t worry about it.
  • Absent Greece, the investment outlook for Europe looks much more positive. With plenty of bad news already “priced in,” the unanticipated outcome is one where a Greek exit is largely an economic non-event for the rest of Europe. (Remember that Greece’s peak GDP was less than 3% of the Eurozone as a whole.)

Overall, our expectation remains largely unchanged. We expect the departure of Greece from the Eurozone to be an extended, messy process, very much a “Grexident” rather than a clean and surgical separation. But while markets may be volatile, we think any sharp downside break will represent a buying opportunity.