The Boy Who Cried Greece

by Kara Lilly, Investment Strategist, Mawer Investment Management's Art of Boring Blog

We were wearing blue. This was a problem.

I didn’t realize this until we took our seats on the coffee shop’s patio where nearly fifty people sat transfixed to a TV watching the Calgary Flames playoff game. We were the only ones not in red. Thankfully, the crowd was so intensely focused on the hockey game, we went unnoticed.

Suddenly, we heard shouts on the sidewalk behind us. I turned around and saw two men standing ten feet apart, clearly inebriated and yelling at each other. One of them darted towards the other, prompting police officers standing nearby to intervene. At this point, the entire patio clientele lost interest in the game, stood up, and moved unapologetically towards the fence to get a closer look. NHL playoffs were apparently not enough drama for this crowd.

The next day, I found myself thinking about that scene. It wasn’t the fight that stunned me; rather, it was the glee on the onlookers’ faces. Although Sunday’s playoff game had more than enough fighting, the crowd on that patio couldn’t escape the lure of watching a new fight breakout. Why are we so quick to crave new drama?

It’s then that I notice an article on my phone with the headline, “Greece orders raid on government coffers as cash dwindles.” The timing was more than appropriate.

Greek-haustion

Greece has been struggling with some manner of financial crisis for almost five years. The situation has become worse of late due to the fallout from the January 2015 election when the leftist party Syriza rose to power under an anti-austerity mandate. Since then, Greece has tried to renegotiate its debt terms with its creditors to limited success. Many now speculate that Greece will default on its debt and leave the Eurozone.

So why is it that the topic of Greece and its economic woes has become so exhausting to investors? If the risk of a big exit has increased, wouldn’t the drama of the situation capture more interest? Yet it seems like the more the media talks about Greece, the more people tune out.

Here is a developed country that is on the precipice of massive default and may exit the Eurozone. If Greece leaves the Eurozone it would be a historic event, one that impacts the lives of millions of Greeks, as well as having consequences for Europe’s banking system and political future. Yet most investors really don’t seem to care. Whether this is because they legitimately believe Greece’s problems represent a low or non-existent risk to their portfolios or that they have just grown apathetic is unclear. But there definitely seems to be some complacency at work here.

The Impact on Markets

Five years ago, the prospect of Greece defaulting spooked investors. They worried that an exit would result in credit losses that would hit the European banking system and spread contagion to other nations such as Portugal, Italy and Spain. These fears were visible in the yields of these nations’ government bonds—which jumped as investors became increasingly nervous—as well as overall volatility indicators such as the VIX (a measure of the implied volatility of S&P 500 index options).

Things are different today. Greece’s cost of borrowing has soared and its yield curve is inverted, and yet the equivalent yields in neighbouring countries are low and market sentiment seems unaffected. Why?

One explanation is that creditors have had five years to ring-fence their Greek exposure. In other words, creditors have had five years to shore up capital in advance of potential losses. Another explanation is that the economies of the neighbouring countries have improved since the European debt crisis commenced, giving investors less reason to be concerned about contagion. Both of these explanations are plausible, but they don’t really tell the full story.

The vital players in this drama are the central banks. Who cares if Greece implodes when central banks have flooded markets with cheap capital? Nowadays, the perception is that financial markets can handle crises like Greece because central banks will just inject massive stimulus into the economy, as evidenced lately by the ECB, Bank of Japan and People’s Bank of China. There may be some truth to this statement. But the idea that Greece could default without any serious repercussions in the market speaks volumes on the level of risk that investors are willing to accept today.

If Greece teaches us anything about ourselves, it is how quickly we can acclimatize to drama. Like everyone who watches the NHL playoffs and expects to see numerous fights, investors today expect drama out of Greece and squabbling out of Europe. Most of us are numb and have become complacent with what is happening there. We may get away with this indifference for the time being, but in the long run, complacency around risk like this is generally a bad sign.

Kara Lilly, CFA
Investment Strategist

Mawer Investment Management