Will Greece default on its debt?
This morning, the CFA Institute released a survey of more than 2,000 financial analysts: 86% of respondents believe that Greece will default on its debt. So the answer is: possibly yes.
What would be the consequences of such a default?
The consequences are already felt: the interest rate on the borrowings, not only of Greece, but also of many financially-challenged European countries has shot up. The market has also become very reluctant to buy new bonds from these countries. Since they rely on new bond issues to finance their deficit, they might have to eliminate it with deep cuts in government expenses. This refinancing problem will only become more acute in the event of a default, making sharp expense cuts even more likely.
Why is that a problem?
Markets are worried that deep government spending cuts will drag the whole European economy into a deep recession. Not only the governments of Greece and other weaker countries will have to cut spending, but the credit losses incurred by French and German banks on Greek government bonds could affect the general access to credit in stronger countries, leading to a recession.
Is it the end of the world?
No. The worst-case scenario we can envision is a “credit crunch” where the European Mega-banks stop lending money. As we’ve experienced in the 2008 financial crisis, Central Banks don’t let that happen. If the European credit market freezes up, it will take a heartbeat before the European Central Bank floods the system with liquidity and restart the credit engine. Markets also fear that the recession spreads to the rest of the world, creating a global recession. While it could happen, this is a long shot scenario, as Europe is not the only engine of the Global economy: North America and most notably Emerging Markets are also heavyweights that could follow a more positive trajectory.
How does that situation affect my PWL portfolio?
PWL portfolios are made of several broad components. Let’s review them:
As we mentioned in previous communications, markets crises are part of an investors’ life. They are unfortunately the dear cost investors pay to capture the equity risk premium (the long-term return difference between stocks and bonds). Our human nature can lead us to believe that every new crisis is unique and that our investment portfolio is endangered. Nothing is farther from the truth: robust portfolios such as those built by PWL have weathered other severe crises in the past and recovered when markets have settled down. This time is no different.
Tony & Peter