Five Things Investors Need to Know On Latest Greece Crisis

For investors, Greece has gone from a romantic vacation spot to a financial nightmare.

The Greek debt crisis is once again rattling global markets, with riots in the street of Athens roiling US stocks at a time when Americans are grappling with their own fiscal mess.

Protestors are seen on the Syntagma square during a protest against plans for new austerity measures.
Vladimir Rys Photography | Getty Images
Protestors are seen on the Syntagma square during a protest against plans for new austerity measures.

Though stocks enjoyed a relief rally Thursdayfollowing a seven-week 6.5 percent pullback, investors remain fearful that the worst was far from over.

"While the fiscal bullets fly and while tear gas and clubs in the streets are the orders of the day, only the truly courageous or the psychotic shall willingly stand up and shoot back," hedge fund manager Dennis Gartman wrote in The Gartman Letter. "The wind is at the back of those who are bearish of all things European, and the wind shall be growing stronger, not weaker in the coming hours, days and weeks."

But how serious is the problem? Will Greek's deep and seemingly intractable problemsspread through the euro zone, cross the Atlantic and invade America much like the collapse of Lehman Brothers did in 2008? Or are the worries overblown?

Here, then, are five things to know about Greece:

1. It's Not Just Greece

The issues plaguing Greece are endemic to many of its weak-sister nations, and the debt contagion could spread from European Union banks to around the world. As a portion of total debt, the $57 billion Greece owns may not seem like much, but the disease can spread quickly.

One option for Greece to pay for its debt is to print money and devalue its currency. But it cannot under EU covenants, putting the nation at a crossroads and the future of EU stability in the balance. Talk is intensifying of Greece returning to the drachma.

"The end game is clear here; the Union is all but over, but getting from here to there shall be over uncharted, unfriendly, storm-ridden waters," Gartman said. "Confusion shall reign and confusion, as we are wont to say, breeds contempt."

Adding to the trouble is that banks exposed to Greek debt get a chunk of their funding from big US-based money market funds.

For example: Ratings agencies have issued cautions to three big European banks about their exposure to Greece.

The upshot for US investors: Not even their money market cash is completely safe, a notion that brings up the nightmares of the Lehman Brothers collapse when a prominent money market fund "broke the buck" and lost its principal.

2. The Disease is Spreading

One need only look at interest rates around the EU to see the contagion: Spain's 10-year notes are yielding a gaudy 5.7 percent, Portugal is at 10.34 percent and Greece is at 17.58 percent—that is, if you dare invest there.

The Greek crisis is undermining the value of the once-mighty euro, and that in turn is driving up yields on debt across the zone.

"The EU has failed to contain the Greek debt crisis, and as history suggests, a domino effect then takes hold," David Rosenberg, strategist and economist at Gluskin Sheff in Toronto, wrote in an analysis.

Rosenberg notes the stress in forex and swaps markets and points out that liquidity, which evaporated during the Lehman crisis, is also being sapped not just in Europe but across the world.

"As we gaze at how the Eurozone ship is sinking, the situation in the United States is dire as well and all the while, the debt ceiling issue is bubbling on the back burner," he said.

The upshot: the European crisis might serve as a nasty template for what will happen in the US if the country does not get its arms around its debt problems.

3. Bad Medicine: Greece Likely Will Restructure

European authorities and the experts at the International Monetary Fund have come up with a menu of can-kicking mechanisms to forestall the seemingly inevitable: Greece at some point will have to restructure its debt, at considerable cost to bondholders.

This is the least desirable result for all the big banks holding that Greek debt. As such, the IMF will likely shovel another 12 billion eurosinto the bottomless Greek debt pit, forestalling a decision about restructuring for another month or so.

"While an additional bailout package may stave off near-term disaster, a major debt restructuring seems inevitable at some point and Greece's future in the currency union is looking ever more doubtful," Jonathan Loynes, chief European economist at Capital Economics in London, wrote in a research note for clients. "Quite how all this will play out is highly uncertain."

The strategy is that in the interim policy makers can devise additional means to address the situation.

The upshot: "If the political and social problems continue to deepen, then market pressures for a more immediate resolution to the crisis will build," Loynes said. "And even if the pressures subside and some form of agreement can be reached next month, it seems very unlikely that this will amount to a decisive solution to Greece's fundamental economic and fiscal problems."

Can Greece's Problem Happen in the US?

4. It's the Global Economy, Stupid

For all of the problems with debt in the euro peripherals over the past 18 months, the US markets have held up remarkably well, gaining nearly 13 percent since January 2010.

There have been three primary reasons for the stock surge: Federal Reserve liquidity programs, a strengthening corporate balance sheet—and the belief that the euro debt issues weren't a broader threat.

With that confidence subsiding, though, the market faces a rougher time.

"If we're going to limp along on a sustained basis at below 2 percent growth in the United States and in the developed world, then Greece and Europe concerns become very overwhelming," said James Paulsen, chief market strategist at Wells Capital Management in Minneapolis.

The only good news comes, though, comes from optimists like Paulsen who still believe the damage can be contained.

The upshot: He thinks investors should use the pullback to add risk to their portfolios.

"When the economy fades everyone goes to their worst fears, which is a confidence problem but also a real problem if you're going to sustain real growth," he said. "I don't think that's the case. We have a temporary slowdown based on temporary events."

5. Yes, It Can Happen Here

Forget the $14.5 trillion debt and the $1.3 trillion deficit and the dearth of political will to come up with a real solution to the US fiscal problems. Simple crowd behavior could cause a major US reaction to the European debt contagion.

Nicholas Colas, chief investment strategist at ConvergEx, analyzed crowd behavior, applied it to the Greece situation, and said the tendency of investors to move with the herd poses a threat to markets.

"Underlying a lot of commentary we read on the topic is the question, 'Could riots or mass protests happen in America?' The simple answer is that history says the answer is 'yes,' largely because they occur with some frequency in all parts of the world, developed and emerging markets alike," Colas wrote.

The upshot: If that is true and if, as one of Colas' friends suggested, "Every guy you add to a group lowers their collective IQ by 10 points," then the danger to US markets is clear, without even accounting for all the similar debt problems the nation faces.

"It should be no surprise that the Greek population is not embracing reform that means higher unemployment and lower standards of living. Or that enough people feel that way to demonstrate. Or that a few people can incite a crowd to violence," Colas said. "True on the streets of Athens, and true in trading stocks."

Jeff Cox is co-author of the recently released Debt, Deficits and the Demise of the American Economy (Wiley).