(openPR) • Bottom line: Uncertainty is high and rising as we enter the next phase of the Greek crisis. Inevitably, the No vote increases the likelihood of a Grexit but it is by no means guaranteed. It all hinges on the negotiation position of the Greek government first and the ECB’s patience second. We are keeping our portfolio positioning unchanged, maintaining our overweight positions in eurozone equities and peripheral bonds. Despite the No vote we still think of Greece in terms of a buying opportunity but like last week we await stronger signals before adding to our portfolio;
• Now what?
- First, we have to await the new proposal from the Greek government to the Institutions. The ball is firmly in the Greek’s court to present a proposal to the Institutions as a starting point for new negotiations. If, as suggested by Varoufakis, the Greek government insists on reaching an agreement on debt restructuring before entering talks on a new ESM bailout we have to expect a firm rebuttal from the Institutions. Also, if the Greek government asks for significant new concessions relative to where the negotiations ended it is unlikely the Institutions will seriously engage. However, if on the other hand the Greek government submits a proposal that is close to its latest version we might see new negotiations starting. The fact that Varoufakis resigned at the request of Tsipras to further the negotiations is a good sign. It is undoubtedly a concession to the Institutions. Whether or not it indicates a higher likelihood for a ‘reasonable’ proposal remains to be seen however. Clarity on this issue should come quickly given the emergency summit called for Tuesday;
- Second, we have to await the ECB’s stance regarding ELA support. As long as the politicians are talking we assume the ECB will remain on hold, neither adding nor subtracting from its ELA support. It is clear it does not want to be the one pushing Greece out of the eurozone. There is a risk though that it will increase the haircut on Greek collateral or otherwise increase the pressure on the Greek banking system to show it is serious about maintaining the rules. In the end, the ECB is the deciding factor between an exit or not. If it retracts ELA support the necessity for a full scale bank recapitalization will likely force the Greek government to print New Drachmas. A bail-in of deposit holders, converting their savings into bank equity, might delay that moment although it will likely come at a heavy social price. We expect the ECB to decidedly move against Greece only when it misses its repayment on July 20. As a result, that is the only truly hard deadline we see;
- Third, it is highly unlikely the Greek banks will open in the next few days. Unless the emergency summit tomorrow goes well and the ECB consequently increases its ELA support we don’t see how they can open. They would run out of money so fast they would have to close almost instantly again. Maybe the summit is able to cobble together some bridge financing that allows the Greek government to repay the IMF, the ECB and recapitalize its banks. That would allow the banks to open again. However, this rosy scenario looks very unlikely for now. That means the economic pain will only grow and social tension will continue to rise while the politicians talk. In fact, it is very well possible that the Greek government will be forced to issue IOUs to pay its bills by the end of this week. This would not necessarily herald an exit, but it would bring it a step closer;
• Again, recent events have a big impact on our scenarios and their probabilities:
1. A new ESM deal is struck before July 20 (40%): This would be the best case outcome, but the roadblocks in terms of political hurdles and economic difficulties are numerous and large;
2. No new ESM deal is struck (60%):
a. Greece defaults on most of its debt, maintains capital controls and issues IOUs to pay its bill while staying within the eurozone (a bit like Cyprus) (30%): This is still where Greece is, but the question is how long it can stay here when it misses the ECB payment and has to recapitalize its banks. How long can it work with IOUs without issuing a secondary currency? We don’t know but we would suspect not very long;
b. Greece defaults on most of its debt, maintains capital controls and after the ECB retracts ELA support starts to issue IOUs first and New Drachmae second, starting the process of a eurozone exit (70%);
• The reasons why we are looking for a buying opportunity have not changed:
- We don’t believe even the worst case scenario is capable of derailing the eurozone recovery. Greece is only 1.8% of eurozone GDP and the vast majority of Greek debt is in highly transparent public hands which limits contagion risk and uncertainty;
- We don’t believe contagion risk is high. Greece is unique in the eurozone in facing short-term solvency issues. No other country, even in the periphery, faces that problem. Combined with the fact that Greek debt has largely been transferred from private to public hands means contagion risk is limited. Of course, liquidity risk could theoretically resurface but with the ECB providing a lot of support (to which they can always add more) that seems very unlikely;
- We don’t believe the ECB will stop QE. In fact it is more likely the ECB will step up QE when faced with liquidity problems in peripheral bond markets. The reason we mention it here is that we see the ECB as a major support to both the eurozone recovery and eurozone financial markets. That support will not go away anytime soon;
• With respect to current portfolio positioning our views are unchanged:
- We maintain our current eurozone equity overweight. We do not want to trim this position because we think the timing around the events mentioned above is very difficult and our investment process still prefers the eurozone over other regions. In other words, we are riding out the volatility when it comes to our current overweight;
- We want to add to our current overweight when we:
a. Trigger a decisive oversold buy signal in our sentiment building block. At the moment we have only triggered a small, tentative buy signal which we do not want to implement while uncertainty is so high. We will only implement a buy signal if it is decisive, which would require the selloff to continue an estimated 2-3%;
b. See new ECB action to support eurozone financial markets. This would likely be an increase in QE;
c. Receive news of deal being struck (even bridge financing around IMF/ECB payments and bank recapitalization would do);
- In peripheral bonds we maintain our overweight position;
- In core bonds we have been advocating incrementally adding to positions, which we continue to do;
