I am sure that the recent fallout in the market has many of you wondering what Greece has to do with US investors and how we can see a such a large decline in the stock market, even with job creation in the US. We will address that below.
I want to remind you that just as in 2008 when the US markets caused the world’s financial instability, that because we stayed the course and maintained our index allocations, the portfolios recovered with the market. Last summer, we rebuilt our index models to include more short-term bonds and purchased protection for those of you who needed it with a large exposure to the S&P 500. This move to overall more conservative portfolios and equity protection will help us weather this European crisis even better than the US financial breakdown. As of Thursday, May 6th, all models remain in positive territory for 2010. We will continue to monitor and learn more about the European Crisis to keep you informed.
“Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.”
The Greek government has recently agreed to receive a Eurozone government bailout from stronger countries in the EU. This bailout is very similar to the way many large US financial institutions were bailed out at the US taxpayers’ expense. In that case, the US government purchased assets from non-government companies. In the European case, governments are giving money to another government to prevent the risk of default of on bonds and other obligations.
The Greek economy is made of mainly government jobs, either direct government employment or subsidized employment. Overall, they have a weak free market system, which may be why people rioted in the streets Thursday due to 2% tax increases and dissatisfaction that the EU central bank did not choose to do more than its $145 billion rescue plan to stabilize the Greek economy.
Greece may be the first of many other bailouts that takes place to secure sovereign debt of other European countries.
Such actions have caused the euro to decrease against other currencies, most significantly against currency alternatives to the euro as a major trade and reserve currency, i.e. the US Dollar, Pound and Yen. Significant losses have also occurred in both European bond and stock prices due to future profits becoming less secure. However, with fast, panicked selling, it is likely that the market has oversold many stock and bond holdings. Therefore, the opportunity to profit from this news has passed and it is unclear whether the market will continue to sell or regain some stability.
Overall, any company linked with global trading will be negatively effected and has already been. According to S&P analysts, the companies in the S&P 500 make up nearly 50% of sales from outside the US in recent years. With the S&P 500 making up nearly 80% of the US market, it follows that this would make US products more expensive to Europeans and therefore drop demand.
As uncertainty in Europe continues, uncertainty in the US will as well. A Greek stabilization plan was passed on Thursday and should begin to stabilize that economy and its problems. There is still fear that other Euro countries may require the same actions, but the EU is showing its dedication to market stabilization.
Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.
There are many factors affecting what is happening in the global marketplace and the US is a major player in all of it. Global investors are flocking to US Treasuries, increasing price through demand, which will help keep rates low. Low rates, in turn, increase demand for borrowing. In the same vein, though, demand for the US Dollar has grown, which has a negative effect on US exports and will slow a full recovery in the US, just like failing stock prices.
Going forward is about positioning portfolios to be participants in the global marketplace while being keenly aware of potential risks. We know that markets can act irrationally during unstable times and the answer for portfolios is to hold the course, maintain diversification and prepare for future risks.
Just as I went to publish this note, the European Union, in a 12 hour weekend meeting, put their final stamp of approval on the Greece bailout. Many economists have dubbed the 1 trillion dollar package the “nuclear option,” but the EU sees the bailout as necessary to keep the euro from free falling in value. The risk going forward is repeating these steps with other countries. If Portugal, Ireland and Spain need the same type of bailout, Europe could easily spend another 500 billion euros. Today as this note is published, the US market is up 400 points in a positive reaction that maybe this is over. I believe that there is probably more to come and hope that it only lasts a week like in the Greece scenario.
Casey T. Smith
Wiser Wealth Management, Inc