The latest installment in the Greek debt saga pummeled global financial markets to start the week. More stock market volatility—bonds, too—comes with swelling concern for a potential Greek debt default or an exit from the currency bloc.
There's also the matter of potential stress on the globe’s financial system.
Talks broke down over the weekend between Greece and its European creditors, which means that stock market tensions ratcheted higher ahead of a June 25 eurozone summit in Brussels and the big Greek debt payment due on June 30. Several media sources are now discussing the possibility of Greek default without a euro exit.
As the high-stakes drama continues to unfold in Europe, "there is a general sense of uncertainty because people still have post-traumatic stress of when Lehman Brothers went under," said Patrick J. O'Hare, chief market analyst at Briefing.com. "Until it happened, you didn't really see how interwoven those trading relationships were.”
Barclays analysts, writing in a research note, emphasized the impending deadline. “If no agreement is achieved before the end of the month, capital controls would be required as the [European Central Bank] would have to increase the haircut on Greek assets and eventually freeze any additional ELA [emergency liquidity assistance],” they said. “A default would also become highly likely, and we think it would quickly lead to Greece printing IOUs to make domestic payments.”
Small Splash or Tidal Wave?
From an economic perspective, Greece’s tiny economy isn’t big enough to rock the global economic boat directly, O'Hare says. However, the uncertainty of a stretched-out Greek drama could create a summer of discontent in a U.S. stock market that’s hung around near record highs to start 2015.
"When you have the U.S. stock market trading with high valuations and it hasn't had a 10% correction in three years, it’s not surprising to see the stock market run into turbulence,” O’Hare said. “Greece is just one more factor that doesn't play well when the market is at high valuations.”
The S&P 500 (SPX) is trading at 17.5x forward earnings, O'Hare says, versus a historical average of around 16x forward earnings. Since May 7, SPX has closed in a range between 2080 and 2130.
With short-term volatility creeping up, the S&P 500 is approaching the lower end of that range, notes JJ Kinahan, chief strategist at TD Ameritrade. "Keep an eye on that to watch to see if there will be a bounce,” he said.
The ramifications from Greece could also spill over to the euro/dollar relationship (figure 1). A stronger dollar has been a chief factor holding back U.S. stock gains as a brawny buck cuts into global profits for big U.S.-based multinational companies.
There hasn’t been a huge move yet in the euro/dollar after the latest Greek setback, but that could change.
“There could be potential ramifications if Greece were to pull out of the euro. There’s no game plan for a country to pull out of the euro,” says Kinahan. “When something is played by ear, there tends to be greater volatility.”
O'Hare weighed in: "No one really knows what it will mean if Greece leaves the eurozone. You can't know what it means until it unfolds."
Kinahan saw only a "small probability" that Greece would actually pull out of the euro, yet he conceded that this will continue to dominate headlines in the days ahead.
"Don't get sucked into it. Greece will be in the news every day until they come up with a solution," he warned. "There will continue to be day-to-day rumor and partial news. Many traders will wait until there is something of substance before trading on this.”