Greece: Default/Agreement Scenarios For The Market

Includes: DIA, QQQ, SPY
by: Jeremy Robson

The present position in Greece is a binary outcome:
1. Greece and the Troika come to agreement on reforms.
This will either be because Greece agrees to the austerity demanded by Germany or because the Troika backs off. It seems to me the present comments from all of the players can reasonably be ignored. This is akin to a game of poker with the players talking their hands. None of the comments are binding, they are just positioning. Making a judgment on how the situation will resolve itself is therefore difficult.
2. Greece and the Troika cannot reach a deal and Greece defaults
The most likely default date would be on the 20th March when its next bond repayment is due.
Note: There is one last very low chance possibility. The Troika says no and Greece looks to default. However, at some point between the 15th February (the date regarded as the last reasonable date for the deal to be done) and the 20th March, one side backs off and the deal gets done. This would be the ultimate bluff by both players; the who will flinch first play. The only reason that I mention this is that it would serve a purpose. The problem with Greece is that it is not its default that matters; Greece is too small. The problem is the signal that it sends to the rest of the PIIGS. If this went to the brink the other nations would know that there was a consequence to the process of not implementing austerity. From the Greece perspective it would mean that politically they had made a stand, which will help their popularity ratings. However, as this is a very low probability I will not discuss it further.
I have no good feel for which of the two outcomes above will happen. If forced to choose, I would suggest the deal will get done as the market expects, but I am not sure.
So what about the market outcome for the two scenarios.
1. A deal is done.
The market will move higher once again. How far is difficult to predict, as we are presently very overbought. I do not believe in a buy the rumor, sell the facts position here. I would suggest that any deal will be greeted with a move higher. The 2011 highs were around 1360 and it seems clear that the market will move up to challenge this mark. How it reacts there is difficult to predict.
2. The deal is not done and Greece moves to default.
Lehman filed for bankruptcy on the 15th September 2008. Below is the chart of the S&P500 for the period just after the 15th.

As you can see, the market tried to rally for 3 days (after a one day shallow sell off) and was unchanged 10 days later. However, after the 25th of September it began to fall and we all know the results after that. I would expect a very similar outcome here. The market will take a few days to work out what it feels the implications are. During that period it will likely move sideways to slightly down (as we are presently overbought). However, after this initial indecision period I would expect either:
1. If Europe begins to unravel (ie: bond yields on Italy and Spain blow out) the move will likely be similar to 2008. The market will move substantially lower.
2. If the policy actions are strong and concerted (ie: bond yields stabilize) I would expect a 2-3 month period of oscillation around a level slightly lower than we have now (possibly between 1200-1300).
I have no strong opinion on which way the Greek tragedy will play out. I am however prepared for the potential outcomes for both scenarios. I would suggest that all investors have strategies prepared (in advance) as this drama unfolds.

One other related point regarding CDS. Please read this article on the makeup of the CDS spread committee and the risks involved - fascinating. The banks that issue the CDS are on the committee to decide if the CDS are to be triggered! Figure that one out.

Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Long RWM