Over the past two weeks, the market has responded to French and Greek elections almost exactly as I predicted: High market volatility, strong dollar, and worse performance in the equity market (NYSEARCA:SPY).
The response, however, has been overblown. In this article, I'm going to argue that even if Greece, Portugal, and Spain all eventually default and exit euro, we will not see the same kind of crisis as we had in 2008. Why? because it has been four years. That seems a confusing answer. But it is exactly what has cured the system, at least temporarily: Time.
Because the security market is generally able to be forward looking with bounded rationality, in a way it is all about expectations. It's a running joke that the market has predicted eight of the past three crises. The only thing that truly spooks the market is surprises.
Prior to 2008, the U.S. economy was enjoying a real estate boom. With enough cheap money around, everything went up. Then the crisis came, it strike most people as a surprise -- there are always a few perpetual bears who would come out to claim victory during the aftermath. However, this wasn't a huge surprise. Big banks such as JP Morgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) were doing OK. Bank of America (NYSE:BAC) got itself into trouble for a different reason. It dived into the subprime mortgage market prematurely by acquiring Countrywide. Although the stock market went down significantly, it was just another bear market: It was not chaotic. That is, until Lehman Brothers collapsed.
The collapse of Lehman was a real surprise to almost everybody. It introduced a liquidity squeeze that made many debt-laden securities appear on the verge of full debacle. By that time, almost any company with debt was hit hard: Boeing was $30 and Caterpillar was below $30. Even consumer staples like P&G (NYSE:PG) lost one third of their value over a short period of time. General Motors (NYSE:GM) went bankrupt. Ford (NYSE:F) was very close. Gold (NYSEARCA:GLD) prices went through the roof. The S&P 500 was at 666 when the market hit rock bottom.
The Federal Open Market Committee and Ben Bernanke in particular made the right call by injecting the market with liquidity and the market quickly recovered.
The key takeaway? The liquidity crisis happened too quickly for companies, especially financial institutions to respond to. Fortunately the government came in and did its job. For this reason, I argue that a debacle-style euro crisis has become a very remote probability as four years have passed. All the financial institutions and governments have had enough time to do their homework thoroughly on different scenarios. Hedge funds have had enough time to evaluate the risks in eurozone securities. The money currently invested in the risky entities are the risk seekers. Their demise, if default strikes, will have much less severe consequences on financial institutions. Moreover, the governments and ECB are both in crisis management mode over the past four years. Anything that strikes, they are much better prepared.
While the dollar might gradually strengthen over the next a few years, no real crisis is coming, even if Greece quits the euro today. With that said, I believe the market has done its due course for the correction. If it goes down another 10%, which I don't think is going to happen, it'd be the best entry point since 2009.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.