A view on Greece

Lothar Mentel - 06 May 2010

As many newspapers have recently punned, Greece is the word. The country's debt troubles have been one of the lead news stories of the last month, and with good reason. Its situation concerns the entire European region, with a specific potential domino effect on other indebted countries such as Spain, Italy and Portugal. Concerns around Greece have affected investor sentiment to the extent that we have seen market falls across Europe, including the UK. Greece's debt and how it relates to other countries, and to markets, is a complex issue. It's useful for investors to have some background on this and know how the Multi Manager team is currently positioning its portfolios which are invested in funds across Europe and the rest of the world.

So what's the background? Quite simply, throughout the last decade, Greece borrowed heavily in order to sustain its economic growth and compete with other European nations. In the wake of the economic crisis, and like many other countries and companies, it has found itself unable to pay off its debts or borrow any more money to do so. Its debt has been downgraded, meaning it has very little value. It also means that Greece now has to pay much, much higher interest for any new debt it tries to issue. The combination of a high stock of debt from the past, that Greece wants to refinance (roll forward) because it now struggles with repayments, and the high interest it has to pay for new issuance, could create a debt spiral where the country eventually just can't meet its obligations anymore. To prevent this, some of the debt has had to be written off, while some is being dealt with in the form of a rescue package. This has been put together by the International Monetary Fund (IMF), France and Germany after extensive discussion with all the lead European nations.

As part of this package, the Greek government has recently issued bonds, all of which it has managed to sell. While this has bought short-term financial relief, Greece is set to pay the price in the long term due to the high interest rates on this debt. In order for this not to result in the debt spiral described above, a major aspect of the EU rescue package revolves around allowing Greece to refinance its debt at lower rates. In effect, by underwriting Greece's debt, Germany and France are ‘lending' Greece their higher credit ratings. As long as Greece manages to sort out its problems, this will not cost the German and French taxpayers. If Greece defaults, then it will. This explains why the German government has been so insistent on a decisive austerity program by the Greek government, so that it doesn't fall back into profligate ways at the expense of the German taxpayers.

With the economies of Europe all inter-related through import and export activity, and relationships between currencies, one country's problems can affect all the others. Not only have we seen market falls and currency fluctuations due to the Greek crisis, but there has also been concern that the rescue package for Greece is setting a dangerous precedent; that other European countries could also ask for help. Moreover, with only a finite amount of money available from the IMF and the European central bank, the more money that goes to Greece, the less money is available for other countries.

Debt is not exclusive to Greece, although it is certainly an extreme example of sovereign debt. Governments across the developed world have amassed a large amount of debt which has, to date, been relatively cheap to repay. But now, more new issuances expected over the coming year will add pressure to interest rates, pushing them ever higher.

However, it's important to put this situation in context. Since the beginning of the financial crisis, economies across the world have undergone tremendous upheavals, and weathered many storms. It is fair to say that economic recovery is now underway. We have moved on from economic freefall, and what we're now seeing are countries attempting to confront financial and economic issues, albeit sometimes shoring up problems for the longer term. Meanwhile, nervous markets are reacting to these issues, displaying an almost hypersensitivity to any potential problems.

So yes, there are still many unresolved issues within economies across the world, but that is often the case after a recession. However, the global economy is improving steadily and this is underpinning current capital market prices. We still expect single digit growth figures for equities this year, but with plenty of ups and downs along the way. Political and economic news, especially if it's not what's expected, will unsettle investors. It's likely that any shocks will drive markets down or, at the very least, stall or inhibit progress until investors have assessed how much of a threat each issue presents to recovery.

The advantage of Multi Manager funds is that we can constantly change their composition in the face of market events. We are currently underweight Europe, but overweight US equities and Asia, and neutral on bonds and UK equities, all in line with how we see markets progressing over the short term. We think it's likely that sovereign debt issues will continue to undermine European markets for some time to come, but that Europe should be able to find a way through, just as the entire global economy is working its way towards full recovery.

Please note that the situation around Greece is changing daily so published information will date. We will keep customers updated.