By Karen Dunn Kelley, Senior Managing Director, Investments1
Greek citizens went to the polls for the second time this year and — in a close vote — granted favor to the New Democracy party, which campaigned on a pro-bailout, pro-euro platform. While much work remains to be done before the Greek financial crisis is resolved, these results reinforce Greece's desire to remain part of the eurozone.
Results and reactions
New Democracy, one of the parties that negotiated Greece's €130 billion bailout in February, won about 30% of the vote in the parliamentary election. Coming in second, with 27%, was the anti-bailout party Syriza. The Pasok party, which participated with New Democracy in the earlier bailout negotiations, was third with about 12%.
It is now up to New Democracy to form a coalition government that can lead the Greek Parliament. Observers expected that New Democracy could partner with Pasok and possibly another party called Democratic Left to form a pro-bailout majority. However, the strength of the anti-austerity sentiment in Greece could present a sizable roadblock that the majority would have to work around.
In fact, while New Democracy has promised to respect Greece's obligations to Europe, its leader — Antonis Samaras — has also asserted that he will seek some respite from the toughest austerity measures.
The reaction from global markets was immediately positive, but the early surge faded quickly. At the time of this writing, the clear winner was the Athens General Index with a gain of about 6%, and Asian markets recorded early gains. But the rest of Europe was up only slightly. And in Spain and Italy, stocks fell and borrowing costs rose. The yield on Spain's 10-year bonds rose past the 7% mark — which is the range that preceded bailouts for Greece, Ireland and Portugal. In the US, stock futures for the Dow Jones Industrial Average and the S&P 500 both declined.
"The message from the markets is that Europe's fundamental problems are by no means solved," said Invesco Chief Economist John Greenwood.
Issues to watch
Invesco has been closely observing developments in the eurozone from political, economic and financial perspectives. At the onset of the crisis, we formed a dedicated group focused on evaluating and potentially mitigating any operating issues that could arise. And each investment team is monitoring the situation for potential portfolio risks — as well as opportunities that may emerge.
The next major milestone in the debt crisis is a meeting of the European Union (EU) leaders in Brussels June 28 and 29. While no single meeting will solve a crisis that's been years in the making, markets are expecting to hear details on a path forward. Here are four areas where we can expect to hear some debate:
Preventing contagion. The consequences of a country exiting the eurozone could be severe, notes Nick Mustoe, chief investment officer of Invesco Perpetual: "The reason why the weaker member states have not rushed for the exit is that they are very aware of the massive economic costs of doing that in terms of recession and social unrest."
In fact, just the prospect that Greek voters could reject austerity had a ripple effect around Europe. Eight days before the elections, Spain requested international funds to prop up its banks after previously resisting such a measure. Europe responded with a deal to supply Spain up to €100 billion for its banks — which was seen as a crucial move toward calming investors before the Greek elections.
An actual exit from the euro by Greece or any other member would have broad and unpredictable consequences on world markets. Therefore, steps have been taken to build a firewall that could help prevent this so-called contagion effect, including a new permanent stability fund that contains approximately €700 billion. We would expect to hear discussion about the adequacy of the firewall initiatives during the summit.
Stabilizing the banking system. As the situation in Spain illustrates, the banking sector in Europe is under particular pressure. Some have advocated that the structure of the permanent stability fund be changed so that it could inject money straight into the banks themselves, rather than issuing funds to the national governments for disbursement.
Additionally, there have been proposals to create a "banking union" that would include measures such as a bailout fund for cross-border banks in the eurozone, as well as an entity to guarantee deposits in all eurozone banks — similar to the FDIC in the US. We should hear more on this topic in the coming weeks.
Creating a fiscal union. Greenwood, Invesco's chief economist, believes that only the creation of a full fiscal union in Europe would alleviate the dangers of contagion and financial collapse in some of the peripheral nations. But the steps that would be required of such a union have been controversial.
Greenwood notes that full fiscal union implies a substantial move toward central or federal control of eurozone government revenues and expenditures — as well as the ability of the federal eurozone government to issue bonds on behalf of all member states collectively — a solution known as "eurobonds." While France, Italy and others have advocated the idea of eurobonds, Germany has resisted. Since Germany is the strongest economy in the eurozone, it would essentially serve as the backstop for the bonds — a prospect that German citizens have opposed.
Another possibility is the issuance of "redemption" bonds: Nations that have debt higher than 60% of their gross domestic product (GDP) could pool that excess debt and sell it as a package. Germany has indicated this could be a workable compromise, and we expect to hear more about this type of solution at the EU summit.
Building growth. Mark Nash, a London-based senior portfolio manager for Invesco Fixed Income, notes that the eurozone crisis is not only about liquidity, it's about solvency, which requires more than austerity measures to correct. "The key to solving the crisis is economic growth, improving tax receipts and, thus, solvency," Nash says.
Beyond that, he suggests, any proposed fixes would be temporary. The European Central Bank (ECB) could provide further liquidity or full-blown quantitative easing, but that would only buy time as borrowing costs within Europe need to be brought down permanently. Even redemption bonds, which could help lower interest rates, wouldn't help underlying growth problems.
Bernhard Langer, Frankfurt-based chief investment officer for the Invesco Global Quantitative Equities team, says building economic growth in Greece is a multi-year issue that may require structural reforms in areas such as tax collection, property ownership and more. "The EU is trying to provide help," Langer said, "But with limited success."
What does this mean for investors?
First and foremost, investors must keep a sharp focus on risk. At Invesco, risk management is embedded into every layer of our organization. It starts at the strategy level; each investment team builds its portfolios with strong risk and quality controls. It rises to the firm level, with dedicated groups monitoring investment, operational and business risks worldwide. And it includes oversight and governance from the Invesco corporate board and independent fund boards.
In addition to monitoring risk, our portfolio managers are also seeking out opportunities. Clas Olsson, chief investment officer of Invesco's International Growth complex, notes that many of the portfolios he oversees hold a certain level of cash they can deploy in the right circumstances. "In a global context, significant weakness in international equity markets on the back of the Greek elections can provide us with some interesting stock opportunities, and we are selectively seeking to identify the most attractive of those."
Michael Hatcher, head of Global Equity and director of research for Invesco Canada, says that in times of turmoil, some investors sell assets indiscriminately, and companies that are typically considered high quality may become available at good prices. "These events can provide great opportunities for investors who are prepared and have done their homework."
It's important to emphasize that each of our portfolio management teams across the globe operates under a disciplined philosophy and process — and those processes don't change in response to market events. In other words, they assess companies by the same set of standards whether the markets are in turmoil or not. Adhering to consistent, transparent processes is critical to our goal of providing repeatable results that are aligned with client expectations.
As events continue to evolve, Invesco will keep you updated. Please contact your Invesco representative or financial advisor with any questions.
