Investing In Greek Elections

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 |  Includes: EPV, EUFN, EWI, EWP, EWQ, FXE, GREK, VGK
by: Trebizond Investments

Ahead of Greek elections on June 17th, we believe European markets will continue to tumble based on justified fear and a lack of central European leadership.

Eurozone economies, the majority of which are forecast for growth in 2013, have been slowing significantly in 2012. The PIIGS bloc continues to lead the growth slowdown, with Greece and Spain the only Eurozone countries forecast to have negative growth in 2013 by the executive arm of the European Union.

Past Elections

European voters have repeatedly punished incumbent governments and rewarded government promising change over the past year. Investors, on the other hand, have shown little faith in the new government's ability to turn around the economy.

  • French elections, May 2012

  • Spanish elections, November 2011

    • Socialist Party defeated, falling below 30% threshold for the first time since 1977
    • Conservative People's Party won for the first time ever, with Mariano Rajoy becoming Prime Minister.
    • Result: to start the iShares MSCI Spain Index (NYSEARCA:EWP) dropped only slightly, but eventually dragged down -30% since elections.
  • Greek elections, May 2012

    • PASOK incumbent: had 129 seats, now has 41
    • New Democracy, who would continue austerity measures, wins most seats with 108
    • Radical leftists SYRIZA win 52 seats
    • Result: the Global X Funds' ETF (NYSEARCA:GREK) has fallen about 35%.

We believe this pattern will continue in Greece. The New Democrats (the leading pro-austerity party) are currently in the lead, but we believe they will not be able to assemble a majority coalition even if they are able to maintain their projected slim margin of victory. A failure of the New Democracy would prove catastrophic for markets who have long shown little hope.

Understanding Greek Legislative Elections and the Current Debacle

In Greek legislative elections, if one party wins a majority, they rule the legislative body. If no majority is reached, the party with the most votes needs to come up with a majority coalition consisting of itself and lesser parties. The majority coalition then controls parliament. If the winning party cannot make a coalition, the second-place party attempts to assemble a coalition. If they fail, the third-place party does the same thing. If the third-place party fails, no coalition is formed and another election is called, usually about a month after the previous election.

Right now, SYRIZA, PASOK, and New Democracy, the three biggest parties, appear to have different visions regarding austerity measures and appear to not want to cooperate. SYRIZA is radically anti-austerity; New Democracy is pro-austerity; PASOK is pro-austerity. PASOK was the incumbent party as economic turmoil swept across Europe and threw Greece into chaos.

As we have seen with elections in Ireland, Spain and even Germany over the past year, severe economic turmoil gives rise to fringe parties, or extremists who gain power in government, and incumbents are punished. In Greece's case, the fringe parties include the once-minor SYRIZA and may expand to other anti-austerity parties including the Independent party (founded in February) and the Communist party.

The June 17th Election and Possible Consequences

Currently, the New Democrats are leading in polls, carrying a slim margin over the SYRIZA. While a New Democrats victory would probably be well-received by markets, due to their pro-austerity preferences, we cannot forget the May elections. The New Democrats won - and were unable to assemble a majority coalition. We predict that the New Democrats would be unable to assemble a majority coalition again - because the other parties, including SYRIZA, Golden Dawn, and the Communist Party, will not cave to the pro-austerity demand of the winning party.

Furthermore, we predict continued decline of PASOK, as they are being blamed for the deteriorating economic situation. PASOK's fall will make it harder for the New Democrats to create a majority coalition. A New Democrat failure would prove catastrophic for markets because the remaining options are either SYRIZA and the rest of the anti-austerity parties, or that there is a failure to reach a coalition, likely leading to a Greek exit from the Euro.

In the event of a New Democrat failure, the duty of assembling a majority coalition would be passed down to SYRIZA, who may be able to assemble an anti-austerity coalition. Regardless of whether they are able to assemble a coalition or not, the outcome would lead to market uncertainty and fear. In light of the fact that the majority of Greeks clearly do not want to enact the austerity measures set out by the EU, our prediction is that SYRIZA will win the election and other anti-austerity parties will also win votes, enabling SYRIZA to form a ruling coalition. The coalition will opt out of enacting the proposed austerity measures, which will cause havoc in markets.

The German government has said that the June elections are the last straw for the Greeks, and may push for the Greeks to be kicked out of the Euro should they not accept austerity measures. Furthermore, there is a possibility of a "bank run" in Greece in the event that SYRIZA loses the elections, as Greeks may lose confidence in their banking system's ability to remain solvent without the Greek government receiving international aid. A bank run would entail Greeks taking their money out of Greek banks rapidly, and as people gradually started to lose more and more confidence, the Greek banks would eventually become bankrupt.

Other possibilities include a psychological "domino effect" to other endangered countries, especially Spain. With all of the recent troubles in the Spanish banking system, investor confidence in the Spanish government and financial system is very low, as evidenced by record-high Spanish bond yields. A Greek exit from the Eurozone could rock the rest of the Eurozone, leading to more bank runs across the continent and an incredibly grim future for the economic union.

Implementation Plan

Key dates: 6/17/12 - Greek elections; 6/10 & 6/17/12 - French Legislative elections.

Straddle the MSCI Europe via the Vanguard MSCI Europe (NYSEARCA:VGK)

  • Requires about a 7% swing in either direction for break-even & profitability

This round of Greek elections may be Europe's second D-day in Europe. The people have already voted out PASOK in the previous elections and replaced them with the New Democrats, who subsequently failed to form a government. The Greek failure is mostly due to the populace's stubborn refusal to accept a bailout and their insistence to keep the current wage and pension conditions in Greece, both of which are financially infeasible. However, their failure to form a government offers more potential for extremist parties like the neo-Nazis, who won around 7% of the vote last time. This is indicative of the population's desperation - and opens up the possibility of a far left coalition.

Greece has enough cash to last until July. They are most likely going to miss austerity measures again; though the EU has been fairly flexible and has stated that they want Greece to stay in the union. This is increasingly appearing to be a poor option for both parties, and it is probable that Greece will default on upcoming bond payments as well. Since we cannot be 100% certain that the Greeks will fail to come up with a solution, one alternative is a straddle play on an ETF.

The MSCI Europe (VGK) has not been a big mover in the past, but we think that this time around we will see a chain reaction. Currently the market is reacting to the slightest European rumors, and any semblance of built-in expectations of Europe are gone by this point. We think a swing after the Greek election results of at least 7% is highly probable. Additionally, we would not stand to lose as much as we would with a one-sided bet.

A. Straddle MSCI Italy (EWI) or Spain

Italy is Greece's biggest trading partner (EU notwithstanding), and a failure in Greece will trigger fears about bank runs in Spain. Either single-country ETF would be a good investment option; EWP is more expensive, but we think there is a higher likelihood for volatility in the future.

B. Short the Ishares MSCI Europe Financials Sector ETF (EUFN)

-While we are confident in our prediction about the Greek elections, EUFN is volatile and may potentially incur heavy losses. Another potential risk is that this ETF has very low volume. A straddle is ruled out, because there are no options for EUFN. One potential trade is to pair this with a call on MSCI Europe, thereby protecting the upside.

C. Buy UltraShort MSCI Europe (EPV)

-Another risky option. This has less downside risk than EUFN because we would buy the ETF instead of shorting it, but we could be burned twice as much should the situation in Europe improve even slightly as the market continues to expect the worse. Again, a safer bet is to pair this with a call on VGK, EWP, or EWI to mitigate risk.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.