Greece: The Slow-Motion Train Wreck Just Sped Up
Why We're Writing
We can't believe that we're still talking about Greece five years after Bailout #1, but the crisis is finally nearing its natural end-point: default. After the last round of negotiations failed between Greece and the Troika of the IMF, ECB and the EC (now vaguely termed "the institutions" in order to be politically correct), the market seems to be surprised. Forward View is not shocked that default is at hand. We hadn't previously ignored the possibility of a delay for the default until late summer, though.
Let's cut through the silliness and focus on the facts: Greece's SYRIZA is built on a foundation of Venezuelan economic policy with Argentine creditworthiness thrown in for fun. There was/is no reason to expect that a Greek government loaded with Communist-leaning academics will ever come to accept austerity and free market reforms. The SYRIZA leadership despises everything related to IMF regulations and German-style belt-tightening. (Thus, the current impasse doesn't surprise us in the least.) All of the "green shoots" in the Greek economy have now been sprayed with herbicide as regular citizens rush to withdraw euros. The subsequent imposition of capital controls following a 1930-style bank run is reminiscent of Monetary Economics 101. Late-breaking news that the ECB is cutting off liquidity assistance for Greek financial institutions will ensure a long "holiday" for banks. These steps have combined to create "The Worst-Case Scenario" so long feared while ensuing that the crisis enters its last stage. Confidence-building and friendly inter-governmental dialogue have ended as raw economic forces take hold. The delay in this collapse of the Greek banking system has benefited other weak Eurozone members, though. How? The risk of financial contagion is significantly less than in 2011, 2012 and even 2013. This crisis will likely be contained within Greece, at least from a financial perspective. We won't even try to forecast the geopolitical ramifications, though.
The Forward View
Greece will default on its IMF debt on July 1st. Period. On July 5th, Greece will also vote down the continuation of the bailout program because the popular right-wing and left-wing parties in the country will spend the next week clamoring to be Bailout Enemy #1. These parties' supporters will follow their leaders' advice in the voting booth. Even if the referendum passed with support to continue the bailout negotiations, who would represent Greece in discussions with creditors? SYRIZA has burned too many European bridges, and the current government would fall anyway. (A new, and possibly even stranger, government would need to be formed after early elections.) We thus forecast that Greece will at least temporarily dump the euro. What happens after that point becomes political, not economic in nature.
As soon as possible, we recommend purchasing ProShares VIX Short-Term Futures (NYSEARCA:VIXY) or shares of the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY). (The latter returns 2X of the S&P 500 VIX Short-Term Futures Index.) These are good securities to hold for the next two or three weeks. We anticipate volatility from 2Q earnings and Greece, but VIXY and UVXY are good hedges. If the situation in Greece turns into a severe Eurozone crisis (unlikely), expect to see the Fed maintain interest rates. We currently predict a mild rate hike in the fall, but limited inflation would allow the Fed to avoid policy tightening if international events threaten the U.S. economy. Buying shares of ProShares UltraPro Short 20+ Year Treasury (NYSEARCA:TTT) is thus recommended as long as the crisis is contained.
The Greek situation will be quite ugly through early July, and global markets will temporarily suffer. We don't see this event becoming anything remotely as catastrophic as the 2008 financial meltdown, though, unless you live in Greece. There is simply no economic justification for a tiny country to bring the world to its monetary knees. The European Union and the ECB have much better safeguards in place to prevent contagion than just two years ago. That's why the Troika walked away. It's also why you can forget the need to liquidate investments in anything except for Greek securities. We'll continue to monitor the situation and publish updates as warranted.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.