Time Running Out for Greece

As of this writing (Sunday 10:35ET), there is no deal yet for Greece. What we know is that with little fanfare and as the clock ticked towards the Sunday deadline, Greece’s newly minted Finance minister Euclid Tsakalotos submitted a formal request for a new three-year 53.5 billion euro ($59.4B) aid package from the Euro zone. In return for the much-needed cash, Greece would immediately commit “to a comprehensive set of reforms and measures to be implemented in the areas of fiscal sustainability, financial stability, and long-term economic growth.” In other words, we need the money so much that we will now agree to tax and pension reform, two of the stumbling blocks that prevented a deal over the past six months. What happened to all of the tough talk about standing up to the Europeans, not to mention the big victory at the polls last Sunday? A funny thing occurred during the fortnight since Prime Minister Alexis Tsipiras called for his referendum: markets were pretty calm and contagion to other markets barely materialized. That fact strengthened the Europeans’ bargaining power. After all, if the markets were basically fine, given all of the uncertainty surrounding Greece, maybe a Grexit wouldn’t be the worst thing in the world, right?

But as Mark Spindel of Potomac River Capital said, “Just because I might be able to survive walking across a major interstate, doesn’t mean I should undertake that experiment.” Even if global markets could withstand Greek’s departure from the Euro zone, wouldn’t it be preferable to mutually engineer and manage it? And does Europe really want to help create a destabilized country, where tens of thousands of Syrian refugees are already knocking on the door?

Perhaps that was the nature of Treasury Secretary Jack Lew’s calls to both European and Greek officials over the past few weeks. While the U.S. is not involved with the negotiations, Lew may have dusted off his history book to review “The Truman Doctrine,” which established that the U.S. would provide political, military and economic assistance to all democratic nations under threat from external or internal authoritarian forces.

The Truman Doctrine arose in 1947, after the British Government withdrew military and economic assistance to the Greek Government in its civil war against the Greek Communist Party. Truman asked Congress to support the Greek Government against the Communists. Of course it was not a coincidence that Tspiras, a far left socialist (some say he is Marxist), went to Russia to meet with Putin last month-it was a not-so-subtle signal that he would be willing to turn to any port in a storm.

Presuming that nobody wants to see Greece adrift, both sides will have to feel some pain. Olivier Blanchard, the IMF’s Economic Counselor and Director of the Research Department summed it up succinctly: “At the core of the negotiations is a simple question: How much of an adjustment has to be made by Greece, how much has to be made by its official creditors?” Blanchard has been vocal about something that few Europeans want to hear: The total amount of debt will have to be cut in order for Greece to get on a sustainable path of progress. And the longer that they wait to write down the debt, the bigger the necessary write down will be. As economist Mohamed El-Erian notes, “Every day that goes by intensifies the Greek economy’s economic and financial implosion…the deeper the economy sinks, the larger the reform and financing requirements to restore its vitality.”

Meanwhile, time is running out for Greece, as cash reserves dwindle and anxiety increases...

CHINA: As if Greece were not enough, gyrations in the Chinese stock markets have prompted some to wonder whether the real contagion risk is centered in Beijing, not Athens. First, some context: Chinese stocks started a steep ascent in mid 2014, after the Chinese government urged investors to enter the market. “Policy makers and state media continued to trumpet the rally even as prices rose well beyond most reasonable estimates of fair valuation,” according to Capital Economics.

The government did a good job of encouraging small, retail investors to enter the fray with gusto. They pushed stocks ever higher until a full-blown bubble formed. At its height on June 12th, the Shanghai Composite was up over 160 percent from the 2014 lows. Not only had prices become completely disconnected from fundamentals, margin debt tripled over the course of a year.

At that point, Chinese officials stepped in to try to prick the bubble that it had fostered. Unfortunately, as is the case with most bubbles, pricks often lead to pops. By last Wednesday morning, the index had tumbled by over 32 percent. Before everyone goes too nutty, it’s important to note that even at the mid-week lows, the Shanghai Composite was up 70 percent from a year ago.

Although the US markets had not been affected by the drop, when Chinese officials halted trading in over half of all listed securities there, US investors got spooked and sold off US companies. (That the rotten day occurred when the NYSE shut down for three and a half hours was pure coincidence.) The quick reasoning went like this: roughly a third of global growth comes from China; if their markets plunge, the Chinese economy will take a hit (that’s why copper dropped to six-year lows); if China slows, then it will be bad for the US exporters; and maybe Greece IS going to be a big deal; so SELL MORTIMER, SELL! The Chinese selling reversed course by the end of the week, allowing all three US indexes to also gain ground on the week…crisis averted!

Federal Reserve: The situation in Greece and the gyrating Chinese market may come up during Federal Reserve Chair Janet Yellen’s semi-annual testimony before Congress this week. Will the central bank stay on course for a September lift off amid international uncertainty?

MARKETS: Existential question: What if the NYSE halted trading and nobody cared? The outage was attributed to a technical glitch and despite being off line; traders had plenty of opportunity to execute orders of NYSE-listed stocks on other electronic platforms, like the NASDAQ.

• DJIA: 17,760 up 0.2% on week, down 0.35% YTD
• S&P 500: 2076, down 0.2% on week, up 0.9% YTD
• NASDAQ: 4,997 down 0.2% on week, up 5.5% YTD
• Russell 2000: 1248, up 0.3% on week, up 3.9% YTD
• 10-Year Treasury yield: 2.41% (from 2.38% a week ago)
• August Crude: $52.74, down 7.3% on week
• August Gold: $1,157.90, down 0.8% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.76 (from $2.77 wk ago, $3.63 a year ago)

THE WEEK AHEAD: As if the news cycle isn’t keeping investors busy enough, we are starting second quarter earnings season. According to FactSet, year-over-year earnings for the S&P 500 are projected to decline by 4.4 percent. The last time the index reported a year-over-year decrease in earnings was Q3 2012.

Sun 7/12 Greek Deadline

Mon 7/13:

Tues 7/14:

J&J, JP Morgan Chase, Wells Fargo, Yum! Brands

8:30 Retail Sales

8:30 Import/Export Prices

10:00 Business Inventories

Weds 7/15:

Delta, Intel, Netflix

8:30 PPI

8:30 Empire State Manufacturing Index

9:15 Industrial Production

10:00 Fed’s Yellen Semi-Annual Testimony to House

2:00 Federal Reserve Beige Book

Thurs 7/16:

Citigroup, eBay, Goldman Sachs, Google

10:00 Philadelphia Fed Activity Index

10:00 Housing Market Index

Fri 7/17:

GE

8:30 CPI

8:30 Housing Starts

10:00 Consumer Sentiment