Greece – Round 3
The month of June closed with a sharp global market decline over the last two weeks of the quarter on news out of Greece. Banks and markets throughout the country closed the last week of June after Prime Minister Alexis Tsipras announced he was calling a referendum on July 5 to determine whether to accept the terms offered by Greece’s international creditors. Greece voted “no” by a wide margin. Unfortunately for Greece, since then, its creditors stuck with their warning that they would have to accept harsher terms if the vote failed. With its back against the wall, Greece accepted.
If you think you’ve seen this movie before, it is likely because the Greek debt crisis started in October 2009, when Greece announced it had been understating its deficit figures. That spooked investors, and by spring 2010, Greece was approaching bankruptcy. To avoid a default, a coalition of mostly European countries issued a bailout. This bailout had some strings attached, specifically requiring budget cuts and tax increases. Greece did not improve and required another bailout in 2012 with roughly the same terms as in 2010.
Since the 2012 bailout, news out of Greece has been mixed. On the plus side, by late 2014, Greece was finally spending less than it was collecting. However, the Greek economy is still in very bad shape. It is smaller today than it was in 2010. Unemployment is north of 25% and much higher for young people. In 2015, Tsipras was elected based on the promise that he would be able to renegotiate with Greece’s creditors. Greece has announced it will stop paying some or all of its debt unless there are changes to the terms.
The Greek government is asking for three changes to the terms of the bailout loans. First, it wants to restore some of the spending cuts. Second, it wants to reverse some of the tax increases. Finally, it wants outright forgiveness of some of the debt it has accumulated. Greek’s creditors have made some modest concessions but are largely sticking to the terms of the bailout loans.
The events in Greece have been building all year, but what does it mean for globally diversified investors? The answer so far: not much. Last quarter, the S&P 500 was up 0.3% while the MSCI Europe and Far East (EAFE) Index was up 0.6.% Despite all of the negative headlines, equity markets were flat or up slightly. The reason the impact has been so low is twofold: Greece is a tiny player in the context of the world’s capital markets, and we still don’t know how this will turn out.
Greece has 11 million people, $242 billion gross domestic product (roughly 0.3% of the world’s GDP) and 51,000 square miles. Ohio has as many people, and Louisiana has a similar GDP and area of land. Greece represents just 0.04 percent of our equity portfolio. None of the bond funds we recommend include debt from Greece, nor other troubled European nations like Ireland, Italy, Portugal or Spain.
The lesson from this crisis (and the others we’ve experienced the past few years) is to never take more risk than you have the ability, willingness and need to take, because the markets will surely test your discipline.
Developments in Puerto Rico Offer Latest Reason Why We Don’t Chase Yield
On June 29, Alejandro Garcia Padilla, governor of Puerto Rico, announced that the commonwealth cannot pay its roughly $72 billion in debts. Puerto Rico’s economy is not in good shape. It has been contracting in inflation-adjusted terms since 2006, and its economy is now 14% smaller than it was a decade ago.
Puerto Rico made matters worse by borrowing enormous sums of money, and the island now has more municipal bond debt per capita than any U.S. state. As the economy declined and the debt rose, people left the island. Puerto Rico’s population is now 10% smaller than it was 10 years ago.
Puerto Rico was downgraded to junk status last year, and was lowered one more level after the June 29 announcement. While neither BAM nor DFA has ever recommended purchasing Puerto Rican debt, that isn’t true of all investors. In total, bond mutual funds hold $11 billion of Puerto Rico’s debt. Another $15 billion is held by hedge funds. The remainder is largely held by individuals drawn to these bonds because of their high yields. As is often the case, higher yields are often required compensation for a higher-risk investment.
A Brief Overview of the Economic Issues in China
In the last few weeks, economic issues in China have also reared their head. While we have heard rumblings of economic problems and the Chinese government falsifying data for years, those rumors have not had much impact on the Chinese stock market. However, June was a different story, with the Chinese market beginning to experience some turmoil.
It is important to note that the Chinese stock market is divided between “A-Shares” and “H-Shares.” The A-Shares are largely restricted to mainland China investors, while the H-Shares are primarily held by foreign investors. The worst of the impact has been felt in the A-Share market. While there is limited access to that market for foreign investors, because the Chinese government has the power to put major restrictions on shareholders at any moment, we do not have any of your investments held in that part of the Chinese market.
Even more important, the stock portion of your portfolio has an overall allocation of roughly 1.8% to China. Given the low weight, the direct impact to the returns of your portfolio will likely be relatively low. While it is possible the troubles in China will spread to other emerging market countries, we believe that this risk is already reflected in today’s prices, so there is no way to time your way in and out of the market.
Foreign and US Markets
As mentioned above, US and foreign markets were largely flat in Q2, while bond markets were negative. Those holding long-term bonds and high-yield bonds felt that impact far greater than you did. Because we believe in holding exclusively short-term and high-quality debt, the impact to you was quite limited.
On the whole, portfolios were largely flat on the quarter and remain positive for the year. After a few really solid years of portfolio performance, this is not a surprise, nor a reason to question the philosophy. In fact, had we been writing this at the end of May instead of the end of June, the “results” would have been quite different. Short-term results only refer to a specific moment in time, while your long-term results tell you whether your performance is meeting your long-term investment needs.
Despite the worldwide market noise, we remain committed to your overall financial plan and ensuring your portfolio design meets the plan needs. As is outlined above, the relevance of these events to your financial life is questionable at best. Apply your earplugs and remain committed to the process and strategies we have employed to ensure your life goals are met.