After a long period of time, the Athens stock exchange has been the worst performing developed market since the start of the year. Although its poor performance so far reflects international market conditions, its sharp fall raises concerns about the future growth prospects of the Greek economy. It has been more than five years since the Athens bourse has had such a bad start. According to MSCI-Barra, the Greek stock market retreated 22.39 percent in local currency till the end of last week, making it the biggest loser in the club of the world’s developed markets. New Zealand was the second-worst performing market, followed by Finland with 17.70 percent. Canada’s stock market was the best performing year-to-date, down slightly by 0.17 percent. The picture of the Greek stock exchange improves when the investment horizon is extended to 12 months or more. This reflects its large annual gains since 2003, mainly thanks to tens of billions of euros invested by foreign investors as Greek investors liquidated their stock holdings. So, it is no surprise that the MSCI-Greece stock index, which posted the fourth-best return among developed stock markets last year, is down 15.87 percent in the last 12 months but fares much better when the investment horizon is extended to the last three or five years. According to MSCI-Barra estimates, the Athens stock exchange has returned 8.45 percent on average annually in the last three years which ranks eighth among the 23 developed markets. However, its average annual return jumps to 22.45 percent in the last five years, making it the second best behind Norway, but it falls to an average 3.64 percent annually over the last 10 years. It stands to reason that the losses suffered by the Athens bourse so far this year mostly reflect the poor performance of stock markets globally as investors discount lower corporate profits against the background of the unfolding credit crisis, high energy prices and perceived economic slowdown. It would not have been normal for rational investors to buy Greek stocks, of banks for instance, at a premium of 30 percent or more compared to their European peers, despite their superior growth profile at a time when risk aversion is running high. One could say that many heavyweight Greek stocks are now paying for their success in previous years when they had become the darlings of the international sell-side and buy-side community. Analysts who had praised them for their drive to expand in Southeastern Europe in pursuit of growth have suddenly become more cautious, cutting their earnings forecasts and price targets for the stocks which in turn brings liquidations by their clients such as mutual funds. They cite a number of reasons, including the higher risk profile of Greek companies because of anticipated difficulties in neighboring countries from which they generate a growing percentage of their revenues. Beyond its control Of course, it is not just the analysts who are behind the Athens stock exchange’s poor performance so far this year. Mutual funds, closed end funds and hedge funds have their own reasons to reduce their Greek stockholdings. In some cases, it is due to redemptions by their shareholders and in others it reflects a more conservative investment approach which translated into a smaller stockholding in their overall portfolio. In the case of hedge funds, it is due to a deliberate effort to deleverage as banks ask for more cash or cut back their credit lines to trim their lending to them. In this regard, the Athens bourse is the victim of an international trend in stock market valuations and capital flows that is beyond its control. However, it would be a mistake to limit the explanation for the bourse’s slide solely to international factors. Basic finance courses teach that stock prices reflect the future stream of earnings or dividends of corporations. Although heavyweight Greek banks and other companies earn an increasing portion of their revenues abroad, most still rely on the Greek economy. So, their earnings growth will be adversely affected by a slowing economy and there are already signs that the Greek economy is slowing. Even the government recognized this by recently lowering its forecast for this year’s GDP to 3.6 percent as persistently high oil prices combine with weaker domestic demand and exports. So, the steep losses of the Athens bourse reflect both the effects of the international credit and stock market crisis, which has spilled over to the real economies in some countries, such as the US, Britain, France, Spain and Italy, as well as the downward adjustment of expectations about Greek economic growth. It is the flip side of the same coin which was observed in 2007 and previous years, when the Athens bourse was racing ahead despite a gloomy outlook for economic activity from businessmen and consumers alike. In those cases, the Athens bourse correctly discounted the underlying strong growth rates of the Greek economy and the double-digit sales and profit growth of local businesses. With the comparative valuation factor out of the equation since the sharp drop in Greek stocks year-to-date has eliminated their valuation premium vis-a-vis their European peers, local businesses will have to prove they can deliver the earnings they have promised in the first quarter and beyond so as not to suffer further earnings downgrades and come under more selling pressure. At this point, their depressed shares incorporate both a higher risk premium due to their smaller size as well as exposure in emerging markets and lower growth prospects in the domestic market as the Greek economy slows down to a still strong 3.4-3.6 percent growth rate.