Euro Debt Crisis: Prepare for Greek Elections and Potential Euro Exit

By Alvin Gonzales - June 5, 2012 | Tickers: INTC, MSFT | 0 Comments

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There are times when paying attention to global developments is the most crucial part of investing. The month of June is one of them. On June 17, Greece will hold elections to form its new government, which will likely determine the fate of Greece and possibly the euro and the European Union (EU). In 2011, the EU had the largest GDP in the world with $17.6 trillion (IMF). Thus, any major changes in the EU will affect the global economy.

Before discussing the implications of the June 17 elections, understanding Greece’s current situation is important. The following table summarizes the Greece debt problem (europa.eu).

As shown in the table, Greece’s debt to GDP and deficit to GDP in 2011 was 165.3% and 9.1%, respectively. To put this in perspective, the Stability and Growth Pact (for EU members) puts a limit of 60% for government debt to GDP and 3% per year for government deficit to GDP. For years, Greece greatly exceeded those numbers.

Furthermore, the current problem with Greece is aggravated by Greece’s inability to print money. The only way Greece can finance its debt is through borrowing. However, due to its high deficit, high level of debt, and slow economy, investors are currently demanding high rates of return for their money. For example, for a 10 year bond, investors are demanding almost a 31% return.

source: Bloomberg

Obviously, this is not practical. As a result, Greece has been borrowing money, through bailouts, from other governments. In return, Greece is required to implement austerity measures (e.g. raising taxes) to try and reduce its deficit.

This is where the importance of the June 17 elections comes in. Depending on the results, the flow of bailout money could be cut off and Greece could be forced to leave the EU. The latest polls show that the leftist Syriza party and the New Democracy party are in a close race for Greek Parliament (Reuters). If Syriza ends up winning a majority of the seats in parliament, it will elect 37 year old Alexis Tsipras as the new prime minister. Tsipras has EU leaders worried because, if elected, he plans on canceling the 130 billion euro second bailout agreement, which was accepted by the previous government and formed with the European Commission (EC), International Monetary Fund (IMF), and European Central Bank (ECB).

Alexis Tsipras wants to keep Greece in the EU and have a renegotiated bailout that does not require austerity measures. He said recently, “There is no danger of us leaving the euro zone. We need to cancel the bailout which has led to catastrophe. We will replace it with a national plan to resurrect the economy” (Reuters). However, according to Germany there is no renegotiating. Greece either follows the previously agreed upon budget cuts and other austerity measures or leaves the EU. German Finance Minister Wolfgang Schaeuble issued a warning, “If Greece – and this is the will of the great majority – wants to stay in the euro, then they have to accept the conditions. Otherwise it isn’t possible” (Reuters).

It is easy to see why Greeks are angry at the required austerity measures. Unemployment is at 21.7% and for youths, from age 15 to 24, unemployment is at 54%. Also, from 2008 to 2012, the Greek economy is estimated to have contracted by approximately 20% (huffingtonpost). However, Greece's lenders are not budging. European Commission President Jose Manuel Barroso recently said, “The fact is that the least difficult way is the full implementation of the second (bailout) programme agreed by Greece and its international partners” (huffingtonpost). However Tsipras is also not backing down. In an interview with TIME, Tsipras threatened,"If we continue taking this austerity medicine, and especially at a higher dose, that's when Greece is going to be forced out of the the euro. And when Greece leaves, the whole euro zone will starts wobbling."

Thus, for the next few months, the situation in Europe can deteriorate rapidly. If Tsipras becomes the prime minister, he will tear up the previously agreed upon 130 billion euro bailout agreement. However, if Greece does this, the countries lending to Greece plan on cutting off the bailout money. Thus, to avoid bankruptcy, Greece may be forced to leave the EU and reintroduce its own currency. This could cause many things from bank runs to mass defaults in Greece, which could cause financial contagion. Also, a Greek exit from the EU could make borrowing, for other EU countries with large deficits or debts, more difficult or impossible. For example, Spanish ten year government bonds, which currently have a yield of about 6.53%, could rise to rates that make it impossible for Spain to borrow. 

In light of the situation, I suggest investors adjust their portfolios. First, I highly recommend that investors stay away from financial stocks. The situation in Europe is fragile and if it deteriorates it is hard to tell which financial companies will be safe. Second, I recommend investors switch to cash, at least until after the Greek elections and when there is more clarity on where Greece is headed. Lastly, for people who do not want to completely liquidate, I would recommend buying strong well established companies, such as Microsoft (NASDAQ: MSFT) or Intel (NASDAQ: INTC), that have lots of cash and can absorb global problems. Microsoft and Intel are cash cows and have cash and short term investments of $53.1 billion and $13.8 billion, respectively. Furthermore, both these companies give out dividends. Microsoft and Intel have yearly dividend yields of 2.74% and 3.25%, respectively.

In conclusion, there is a lot of uncertainty in Europe, especially with Greece and the upcoming June 17 elections. However, the risks and rewards are not equal. If nothing disastrous happens in Greece (if cooler heads prevail), the current situation does not really improve. Yes, after the elections, there will be more clarity on where Greece and Europe are headed. However, Greece and other countries will not reduce their large debts and deficits overnight. Recovery will take time and investors will have plenty of time to react and adjust to the situation. However, if the situation in Greece deteriorates (most likely rapidly), investors in the market could lose a lot of money in a short period of time. Thus, the best move right now is to take money out of financial stocks, convert to cash or holdings in very strong and cash rich companies like Microsoft or Intel, and wait for a clear plan for Greece to emerge.

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