Markets must see the forest, not trees
The Greek economy may be on the right path but the situation is still fragile. Therefore, the sell-off in Greek stocks and bonds last week should not surprise. In addition to market-specific reasons, many investors appear to be more concerned now than a week ago about political instability and the prospect of snap elections. The outcome of the elections for the European Parliament next Sunday will show whether their concerns are justified. In any case, the anger of Greek voters over austerity measures should not be underestimated.
On several occasions in the past we have argued that markets had taken a sanguine view of political developments and tended to underestimate political risk. The sharp fall of Greek stocks and bonds last week indicates that at least some investors appear to be taking political risk more seriously now. Although other reasons have contributed to the drop, particularly a circular on the taxation of Greek bonds which spooked investors, the driving force behind the rout was politics.
The Athens Stock Exchange general index recorded a weekly decline of 8.68 percent to 1088.25 points, entering negative territory since start of the year. The benchmark index had closed at 1162.68 points on December 31, 2013. While some stock market participants attribute the sharp drop to a technical correction, following the successful completion of the share capital increases by major banks, and the spillover from the bond market rout, concerns about political stability dominated.
A similar picture emerged in the bond market where the 10-year Greek yield spiked to 6.86 percent on Friday from 6.12 percent a week earlier, a sharp move by bond market standards. In so doing, it helped pull other bonds of the europeriphery lower with the 10-year Portuguese yield rising to 3.75 percent from 3.55 percent a week earlier.
It is noted the yields of fixed-rate bonds go up when their prices fall and vice-versa. Of course, a circular on the taxation of Greek bonds also contributed to the pick-up in yields last Thursday. The fact the yields did not fall back to previous levels after the government revoked the circular indicates that factors were at work, with market participants pointing to concerns about rising political risk.
Of course, one may ask why investors became worried last week and not before. The obvious answer is because the markets usually get edgy before major elections and the main opposition party SYRIZA party has made it clear that it regards the elections for the European Parliament next Sunday as a vote of confidence in the coalition government. But analysts and others think there is more into it. They suggest the change in market attitude relates to recent opinion polls, favoring the leftist SYRIZA over the conservative New Democracy party.
According to them, SYRIZA has taken a clear lead over the conservatives lately while Elia, the umbrella under which the junior coalition partner, PASOK, is participating, continues to perform poorly in public opinion pills. This does not bode well for the coalition government. Still, a good portion of citizens have yet to make up their minds and this may produce a large swing in the vote, even at the last minute, affecting the election outcome. Their view coincides with our own information from various polling companies and analysts who have analyzed the data.
Still, we have to wait and see whether the outcome of yesterday’s local elections and the impression it may create on the general public will have an impact on next Sunday’s elections for the European Parliament and the campaign in the last few days. It should also be noted that the far-right Golden Dawn party appears to be firmly in third place and doing better than published rolling opinion polls show.
Therefore, market participants may have a reason to revise their stance on the Greek political risk if indeed the trend in recent opinion polls holds and the coalition government weakens considerably after next Sunday’s elections. In the latter case, one should not rule out snap elections. That said, one week in politics can be like a century in real life so anything can happen.
Nevertheless, it is only natural for people to be angry with some 27 percent of the labor force being out of work and disposable incomes being cut by some 20 to 30 percent on average since 2009 on the back of tax hikes, pay cuts and tight credit conditions.
On the other hand, some pundits advise caution because politics is volatile and may hide thrills, though not necessarily bad ones. Although swings in opinion polls may justify short-term stock and bond market volatility, they are not a good advisor for medium-to-long-run investments.
So, Greek stocks and bonds may continue to underperform their European peers this week leading up to next Sunday’s elections, as concerns about political instability remain and investor bias toward the underestimation of it is gradually removed. However, investors may be better off to focus on the forest rather than on the trees and to take the medium-to-long term view on the Greek economy regardless of political developments.
