Investors Are Facing Up to Reality of Greek Debt Default
An orderly Greek debt default could help quell some of the disorder in U.S. markets at least for the moment, as investors focus instead on the domestic economy and hope conditions continue to improve.
Europe has dominated movement in both stocks and bonds for the better part of a year now, as investors wondered what would become of debt-laden nations and how that would impact U.S. banks and the broader economy.
Consensus is building, though, that the most troubled nation, Greece, is about to defaulton a March 20 debt payment but in a way that may not be disruptive for markets that have been trying to price in just such an event.
Greece is likely to give bondholders a haircut in the 50 percent range and could issue new bonds with lower coupon payments to help handle the debt better. The coupons likely will be in the 3 percent to 4.5 percent range, according to Dow Jones reports.
If the default can be managed by the European Central Bank through mechanisms employed during the hundreds of other sovereign debt defaultsover the past couple of centuries, the market can manage.
But that's far from a sure thing, considering the unique set of circumstances in which Greece finds itself as a member of the European Union, a political and monetary alliance that makes debt defaults a bit more complicated.
In late October, Greece managed a debt renegotiationthat the International Swaps and Derivatives Association declared "voluntary," meaning it did not trigger credit default swaps and a payoff to investors betting against the sovereign debt . That's unlikely to happen this time, a situation that will benefit the CDS holders but hurt those who have to pay off on the insurance markers.
"Clearly the ECB has made some progress. The actions in the eurozone have been better," said Diane Swonk, chief economist at Mesirow Financial in Chicago. "It appears at the moment that the market is accepting a Greek default as inevitable, and it will be an orderly default. But that can change on a dime."
Investors might be better off focusing closer to home for a while.
Europe's greatest periods of disruption to the markets have been times when the U.S. economyhas performed most poorly, according to research from Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis.
Tracing periods since the crisis intensified in January 2010, Paulsen found the correlation between the euro and the U.S. stock market has been near perfect — a 0.9 in correlation measures, which consider 1.0 as a total match — during the times of the worst economic news.
Conversely, a weaker euro and weaker stock markethave coincided less frequently as U.S. economic news has improved, with the period since October as a marked example.
"The eurozone crisis seems to dominate the U.S. stock market only when and only because U.S. economic momentum proves disappointing," Paulsen told clients. ""It seems European fears will likely be part of the global fabric for years, but should not be overly significant for U.S. stock investors as long as the U.S. economic recovery remains healthy.
The durability of that recovery, though, remains in question.
While most economists expect gross domestic product growth for the fourth quarter to register near 3.0 percent, those gains could be temporary.
"Fourth quarter growth was driven by inventories and net exports, while domestic demand was hindered by a huge drop in defense outlays," Citigroup economist Peter D'Antonio said in a note. "The core of the economy, private domestic demand, seemed to lack vigor at yearend."
D'Antonio's GDP forecast of 1.75 percent by the end of 2012 jibes with others who believe economic growth will see a slowdown that could drag growth closer to 1 percent.
In that event, troubles in Europe could again take over investor sentiment, even if Greece figures out a way to default on its $14.5 billion euro bond payment in March without tanking the market.
"You've got to have some sense of pain felt, and you just want to contain it," Swonk said. "That's about the best they could hope for and the best we could hope for."
Indeed, investors have had plenty of time to digest worst-case scenarios for Europe.
"Essentially, the market wants to get it out of the way," said Andrew Wilkinson, chief economic strategist at Miller Tabak in New York. "As with most pieces of negative news at the moment, the downside appears increasingly limited. All of the negative factors that stacked up at the end of December are diminished in terms of importance to investors."
Looking at market behavior, stocks have moved closer to the July 2011 highs than their October lows, even with a Greek default dead ahead, said Rick Bensignor, chief market strategist at Merlin Securities in New York.
"This has the potential to be a disruptive event, but as time goes on there's more of a sense that this (default) is going to happen," he said. "So it would not be the disruptive event that it would have been six months ago."