The markets have suffered yet another horrible week. And it’s all down to a tiny country nestled on the outskirts of Europe.
But it’s not Greece that’s rattling the markets so much as the disease she carries. The disease is coming out of incubation and the symptoms are starting to show. And as they do, investors are worried about how far this disease has spread – where will the symptoms show up next?
I’m not going to try to gauge the severity of the disease. Today, I want to look how it’s being covered up and how we might be able to profit from it.
We’ll look at how politicians and bankers are trying to convince investors that this disease is contained. ‘There’s no issue of a pandemic’ they say.
The three stages of financial grief
A couple of days ago, we looked at how corporate leaders sometimes will try to cover-up bad news. I showed you how this can lead to a three-phase spiral of profit warnings.
First there’s denial – company management reassure investors there’s no intractable problem. Then comes admission – management can’t hold back the truth any longer. That’s when the stock price falls apart. Lastly, as fear drives away key customers and employees, it’s likely to cause a self-fulfilling third wave of profit downgrades.
Unfortunately, there’s more than a striking similarity between how businesses and nations manage downgrades. For the politicians and central bankers, the last thing they want to do is admit that they haven’t got a solution to the euro debt crisis.
Greece embarks on the Woolworths plan
For well over a year now, we’ve been told that nothing’s wrong – ‘Go ahead and buy Greek debt – it’s safe as houses’… That was during the first phase of denial. The guys at the top reassured us they could fix European debt issues with a simple $1trn bailout fund.
A year has come and gone since then, and now we’re heading into the dangerous second phase. That’s when the guys at the top admit there’s a serious problem. The Germans are calling for Greek debt to be ‘re-scheduled’, meaning bondholders should take a haircut. Mutterings about Greece leaving the euro grow louder… basically all the things that we’d been told could never happen are now being considered.
Meanwhile Greece is forced into using the same tactics employed by failing businesses. That is they sell off the best parts, cut costs to the bone and borrow as much money as they can get their hands on.
George Papandreou’s government plans to sell off 50bn euros-worth of state assets. They’re trying to push through a new & austere’er austerity bill (leading to the masses rioting in the streets) and they’re hoping to get their hands on a €12bn loan from the IMF pretty soon.
You could call this the Woolworths plan for recovery.
Of course, seasoned investors know the plan is flawed. Selling assets means giving up their future income. More loans land you with a higher interest bill. And last, but not least, cutting costs to the core is a dangerous gamble. There’s a chance that they’ll throttle the goose that lays the golden egg – if you cripple the economy, then tax income deteriorates even faster.
What Greece needs is a pre-pack administration. And at some point I expect it’ll get one. But as we wait for that.
The Greek disease is spreading
The markets know that Greece represents the thin end of the wedge. As the market deals with Greece, attention is already focused on the next nation in trouble. It reminds me of the banking crisis. The markets drove one bank into the ground, then as the likes of Bear Sterns or Lehmans got smashed, the market went hunting for the next shoe to drop.
In the UK too, sustained assaults on stocks like RBS and HBOS drove them into unholy mergers and bailouts.
As and when Greece heads into its form of administration, it’ll set a precedent. Say bond-holders lose half the face value of their bonds, then the markets will have an idea of what’s going to happen to the other countries at the thicker end of the wedge.
And that’s why the markets are running scared. It’s not Greece that matters – but what its resolution means for the world’s other big debtor nations.
Your best bet
I really don’t like the look of what’s shaping up here. And I’ve already made my move. The short on bank stocks has been performing precisely as planned. Since I wrote about the UK’s rotten banking sector, the index is off nearly 15%.
And nearly 5% of that fall happened in the last few weeks since I reiterated the idea of shorting the banks. The banking index has fallen some 210 points in just three weeks. If you took my advice, you’ll have been pleased for this hedge against the market turmoil developing.
I’m still short the banks. They’re the big holders of sovereign debt and they’re the ones that are going to feel the brunt of restructuring of these bonds.
Next week I’ll be looking at a safe haven investment class during these dangerous times. It’s not a class of investment that the City boys will be picking up… this is definitely one for the private investor. So stay tuned.