The relief rally Monday following Sunday’s Greek election was short lived.
To be sure, the outcome of Sunday’s election is near-term good news for investors. A government led by the pro-bailout New Democracy is likely to follow more of the austerity program and to try, at least for now, to keep Greece in the euro.
That said, there are two main reasons why markets aren’t continuing to celebrate the Greek vote:
1.) Most importantly, worries about Spanish banks and Spain are taking center stage again. Spain’s debt yields are in the worrisome 7% range, the level that led to bailouts for Greece, Portugal and Ireland. Market attention is now focused on how the European Union will address Spain’s problems at upcoming meetings.
2.) Greece still faces formidable economic obstacles. Even with the New Democracy win, there’s likely to be some back sliding on the March agreement between Greece and other European countries. In addition, further defaults by Greece and an eventual Grexit are still significant long-term risks.
So what does this mean for investors? Looking forward, investors should continue to watch for three developments:
1.) Further Greek banking system outflows, which would signal a worsening crisis.
2.) More clarity on the rescue plan for Spain and on how Spain plans to recapitalize its banking system. The Spanish banking system is arguably a bigger threat to Europe than a Grexit.
3.) More signs that Germany is softening its position toward eurobonds. Any development in this direction would signal a growing eurozone consensus toward how to resolve the crisis, a positive for markets.
I believe that a worsening eurozone crisis can still be avoided if European politicians get more aggressive in addressing their region’s problems. However, as there’s little likelihood of an imminent solution to the eurozone crisis, the region is likely to continue to be a source of uncertainty and market volatility in the near term.
As such, while I do like some countries in more economically stable northern Europe such as Germany, Norway and the Netherlands, I continue to advocate underweighting Italy and Spain, which look cheap for a reason.
In addition, I continue to believe investors should consider a defensive portfolio positioning through high-quality, dividend-paying funds; defensive sectors such as global telecommunications, global mega capitalization (mega cap) stocks, and US and international minimum volatility funds.
Potential iShares solutions include the iShares S&P Global Telecommunications Sector Index Fund (IXP), the iShares High Dividend Equity Fund (HDV), the iShares Emerging Markets Dividend Index Fund (DVYE) and the iShares MSCI All Country World Minimum Volatility Index Fund (ACWV).