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

Greek Fatigue

Greek Fatigue: Condition affecting investors and news junkies, caused by five years of reporting on the exact same topic. Symptoms include weariness, eyes glazing over and sleepwalking through broadcasts/columns/blogs predicting doom and gloom. (See: “US Debt Ceiling” and “The Boy Who Cried Wolf”.) I know you don’t want to hear about Greece again, but we’re getting down to it. Euro group leaders (the European Central Bank (ECB), the European Commission (EC) and the International Monetary Fund (IMF)) were banking on weekend progress to restructure outstanding loans to Greece, which would unlock €7.2B of the total €15.3 billion in rescue funds. Without that money, Greece will not be able to make a €1.54 billion ($1.73B) payment due to the IMF on Tuesday. In order to get the lifeline from the Euro group, Greece must agree to more taxes and an increase in employee pension contributions.

THEN, in a twist worthy of a Broadway “11 o'clock number” (“Rose's Turn” from Gypsy being hands-down the best, ever!), in the wee hours of Saturday morning, Greece’s Prime Minister Alexis Tsipras went on television and called for a surprise referendum for July 5^th, where Greek citizens will have the opportunity to vote on the euro group’s demands. Tsipras called on Greeks to vote “no to the ultimatum” and at the same time, sent his Finance Minister Yanis Varoufakis into the Euro group meeting to ask for a one-month extension on the talks to allow time for the vote. European officials quickly rejected the request, saying there was “no support for that.”

Over the weekend, Greek Prime Minister Alexis Tsipiris stunned the world with an announcement of a surprise referendum next weekend, where citizens will have the opportunity to vote on the euro group’s demands for an increase in taxes and pension contributions. Concurrently, Greece asked the euro group for a one-month extension to the negotiations, which officials quickly dismissed.

Then the European Central Bank announced that it would not increase short term funding which has allowed Greek banks to meet withdrawal demands. Without the lifeline, Greece had no choice but to announce that banks would be closed for a week and to impose capital controls, which limit how much money citizens can withdraw from the banks (€60/day, though no limit if drawing from a non Greek bank card, so foreign tourists are not affected) and transfer out of the country.

Barring a last minute-effort, Greece is now likely to fall into technical default on the IMF loans, though not necessarily on other debts. That puts the country in a dubious club that includes Cuba, Zimbabwe and Somalia, but it would not immediately lead to cascading problems. That is, unless Greek bank depositors make a more fervent dash out of the banks and investors get antsy, during the week leading up to the vote.

The total outstanding amount extended to Greece is nearly $270B, of which the European Central Bank’s exposure stands at about $170 billion. About 80 percent of the ECB’s money is keeping the Greek banking system afloat and the rest is in the form of longer-term Greek bonds, which require a $3.9B installment on July 20^th and the remainder must be paid by the end of August.

I know that it’s easy to paint Greece as the screw up, prodigal son in this story, but Irish economist Karl Whelan wants to set the record straight. Whelan cited the EC’s report on Greece from last year, which found that total public sector employment declined over 25 percent from 2009 to 2014. During the same time, Greece reduced its fiscal deficit from 15.6 percent of GDP to 2.5 percent, according to the OECD.

Perhaps because Euro group members are not willing to discuss the progress that Greece has made or the pain that ordinary Greeks have endured, Tsipiras and many within Greece’s ruling Syriza party are balking at even more austerity, which the party had promised to bring to an end when it successfully won seats in parliament in January.

The defiant Greek posture only inflames emotions more, leading many in Europe to posit that a default and exit from the euro zone, combined with a new (and much devalued) currency and structural reforms, would be best for Greece in the long run. The Financial Times Martin Wolf is not so sure: “Far more likely is a period of chaos and, at worst, emergence of a failed state…Neither side should underestimate the risks.”

While a deal between Greece and its creditors may finally emerge, “it still looks unlikely to include the substantial debt relief needed to end the crisis and eliminate the risk of Grexit”, according to Capital Economics. That’s a shame, because the answer seems so clear: European financiers pushed the ultimate drug into Greece—cash. Now that the addicted country is coming off the stuff, it would be foolhardy to go cold turkey.

US Jobs Report in a holiday-shortened week: Here in the US, there continues to be evidence of economic improvement. New and existing home sales reached 6 to 7 hear highs; personal income and spending jumped in May; and sentiment came in at a 5-month high. The better than expected results overall is prompting some economists to increase their projections for the June employment report from 215,000 to closer to 250,000. And there may be even more progress on wages: “Adjusting for inflation, disposable income for the first five months of the year is up a strong 3.6 percent compared to the same period last year,” according to Joel Naroff. Just a reminder, the report will be released on THURSDAY at 8:30ET, due to the Friday observance of Independence Day.

MARKETS:

• DJIA: 17,946 down 0.4% on week, up 0.7% YTD
• S&P 500: 2101, down 0.4% on week, up 2.1% YTD
• NASDAQ: 5,080 down 0.7% on week, up 7.3% YTD
• Russell 2000: 1279, down 0.4% on week, up 6.2% YTD
• 10-Year Treasury yield: 2.47% (from 2.27% a week ago, highest yield in 9 mos)
• August Crude: $59.63, down 0.6% on week
• August Gold: $1,173.20, down 2.4% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.78 (from $2.80 wk ago, $3.68 a year ago. AAA predicts that 35.5 million people will drive over Independence Day weekend, the most since 2007 and they will pay the lowest price at the pump since at least 2010)

THE WEEK AHEAD:

Mon 6/29:

10:00 Pending Home Sales

10:30 Dallas Fed

Tues 6/30:

GREECE PAYMENT DUE TO IMF

9:00 S&P Case Shiller Home Price Index

9:45 Chicago PMI

10:00 Consumer Confidence

Weds 7/1:

Motor Vehicle Sales

8:15 ADP Private Sector Jobs Report

9:45 PMI Manufacturing

10:00 ISM Manufacturing

10:00 Construction Spending

Thurs 7/2:

8:30 June Employment Report

Fri 7/3: MARKETS CLOSED IN OBSERVANCE OF INDEPENDENCE DAY