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The Eurozone and Greece: June 19, 2012

John Gorlow | Jun 19, 2012

Market Update


The possibility of Greece leaving the Eurozone thereby triggering a string of sovereign defaults remains a key focus of the market.  A re-run election in Greece, June 17, failed to curb uncertainty. It remains at a high level.


Aside from the sovereign debt issue, there is concern about the impact of the crisis on the Eurozone banking system. European Central Bank refinancing in early 2012 provided short-term relief for the banks, but market pricing indicates worries over the longer-term solvency of many institutions.


Meanwhile, Europe’s inability to deal conclusively with its problems is causing international tension as governments elsewhere voice concern about the impact of the crisis on global economic growth. Germany’s critics accused it of pushing austerity at the expense of the growth needed for the peripheral countries to pay back their debt.


While parallels are being drawn between this phase of the Eurozone crisis and the Lehman Brothers collapse of October 2008, measures of stress in equity and money markets are far below the levels seen during that period.


One equity measure is the Chicago Board Options Exchange’s “Volatility Index.” The index has been hovering around the low to mid-20s in recent weeks, which is significantly lower than its 2008 peak levels near 80.


In the credit markets, a closely watched barometer of stress is the three-month London Interbank Offered Rate, or LIBOR. Leading into the Greek election, the three-month US dollar LIBOR was around 0.47% and had been steady at those levels for twenty consecutive sessions. In comparison, LIBOR was at more than 4.0% in October 2008.


Another measure of sentiment is the credit default swap (CDS) market. The pricing of Eurozone CDSs moderated earlier this year as refinancing agreements were reached, but they have since returned to near the elevated levels of December.  In this case, risk measures are much higher than in 2008 when most of the focus was on the banking system rather than on sovereign debt. But this is also another way of saying that much of the bad news is already in the price.


Nearly three years since it began, the European sovereign debt crisis continues to create great uncertainty in global financial markets. The crisis has raised questions not only about the sustainability of sovereign debt burdens in Europe, but also about the future of the common currency.  Further, investors globally are expressing concern about the impact of the crisis on economic growth rates and the financial system itself. However, as we have seen, the extent of uncertainty, as expressed by information in market prices, is nowhere near the levels reached during the Lehman crisis of late 2008.


In sum, this is understandably an anxious time for investors. But markets incorporate all known information and widespread anxiety is already reflected in prices.  It is what happens next that counts and no one can predict the future.  So our approach remains the same.  Basing investment decisions on forecasts is counter-productive, especially in such a rapidly developing and multi-faceted story. As always, news is quickly reflected in prices and there is little to be gained from speculating about likely outcomes.  The best policy is to remain committed to an undivided investment philosophy: namely, passive and index investment strategy. Onward and upward.


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