The Case for Investing in Greek Bonds

Includes: ERO, EU, EZU, FXE, IEV, VGK
by: The Wild Hog

I know the title may seem completely out there, and frankly, it is. But indulge me, if you will, and bear with me as I present some thoughts to you. The current Greek 10-year bond was issued at €98.42, with a coupon rate of 6.25% paid annually.

However, things began to change for bonds across the globe as the eurozone contagion crisis unfolded. As the eurozone crisis began to unravel, yields fell in bonds across the globe in a typical flight to safety fashion. However this was not the case for the Greek 10-year note. As expected, investors demanded a premium for the inherent risk of default, thus driving yields up.

Even though it may appear that Greece will default on its debt, in my humble opinion, this will never happen. For starters, let's look at the last time a country defaulted on debt, Argentina. When Argentina defaulted, the aftermath was chaotic. The number of people who lived below the poverty line increased pretty significantly as did the number of people in extreme cases of poverty. This resulted in ruins from the time period 1999-2003 as GDP remained negative on a year-over-year basis. Countries devalue their currency when they are in default, with GDP getting crushed. To combat this, Argentina devalued the peso, thus boosting exports and with it, GDP. However Greece doesn’t have this option being tied to the euro, thus presenting the case for more IMF and EU bailouts.

If Greece were to default and thus possibly leading to a monster decrease in GDP, the economy would quickly slip into a recession, and thus rendering it unable to pay its debts down. The problem with this is that Greece is attached to the eurozone. Now if one country is experiencing incredible debt to GDP ratios, maybe other countries within it may experience similar situations and will be left helpless to pay back debt. This would create a domino effect, which is basically the definition of contagion.

Our political leaders are smart these days (that was extremely painful to say) and understand the consequences default would have on the global economy and the recovery underway. The recovery would be shattered, jobs would be lost, investor confidence would decrease, bank lending would dry up (credit lines are beginning to freeze as we speak), and stock markets around the world would tumble. A bailout of Greece has already been put into play and more may be necessary. But I digress.

Moving back to the case for investing in Greek debt leads us to a discussion on yields and returns. Below we have the S&P and Dow and their returns for the past 10 years. The Dow is down 11.64% and the S&P is down almost 30%. These are brutal returns, especially for someone looking to save. Now of course I'm a realist and do realize that there were stocks that performed magnificently during this period, but the average investor is typically limited to the performance of the overall market.

A Greek bond can be purchased at steep discounts these days, and the yield to maturity is above the coupon rate. Note here that the price for the bond was once trading at around €65, which is an absolute steal. This was a perfect buying opportunity for someone looking to scoop up a Greek bond and benefit from the price appreciation in addition to the monster yield it was providing. Does this mean that all opportunities are lost? No, not in the very least, in fact, I would suggest purchasing whatever sovereign debt one can get their hands on.

One rebuttal to my argument for purchasing such risky debt could be "Why not purchase US Treasuries since they are virtually free of default risk?" Well my friends, the answer lies below. Take a peek at yields here. As you can see, the generic 10-year Treasury note is offering around 3.2%, almost 3X less than the Greek note. One must also consider that 10-year notes serve as a safe haven trade, meaning when there is fear and speculation of a downward moving market, investors pour cash into this note, thus driving down yields and prices up. This is a highly unlikely scenario for Greek notes.

To summarize everything that was discussed here today, I will simply state that Greece will not default. Even if there is a strong "probability" that they will, the odds are highly unlikely. As we speak, the PM of Greece has stated, "Greece has tremendous growth potential." Now it may be naive to believe this wholeheartedly, but still one must ponder why he would be so strong and affirmative about Greece's future.

Disclosure: No positions