Is A Grexit Possible Before The German Elections?

Greek Exit, German Elections
The probability of Grexit has increased due to several factors:

  1. Austerity measures are being implemented, particularly the placement of 25,000 public sector workers into ‘reserve’ (from where they can be fired after 8 months)
  2. The governing centrist coalition has had its majority in the 300-seat parliament reduced from 167 to 155 due to a junior coalition member quitting over austerity measures
  3. Greece has achieved primary surplus, which means that the austerity is enacted purely to pay the official sector cost of interest on loans. However, the probability was low to begin with.

While we do believe that the three factors above have increased it, we are talking a jump from somewhere in the single digits to 10-15%. This is because:

  • Euro area exit is unpopular in Greece. Even the far-left SYRIZA has caught on that Greek voters fear uncertainty and therefore do not want to risk Grexit.
  • Post-German election, an OSI (Official Sector Involvement) is likely, with further cuts in interest rate payments and extension of debt maturity at the very least
  • Greeks have an upper hand in negotiations due to reaching primary surplus, so they will likely eventually receive OSI

An OSI is not an option, and cannot be discussed, in the run-up to the German elections. So it won’t be. However, it is the likely outcome eventually of another Greek showdown. German election is two months away, including August which is usually completely dead in terms of news flow out of Europe. As such, it is highly unlikely that Greece will come up before the election. Particularly not after they already received the funding from the official sector and have passed the necessary legislation. As they fail to deal with implementation of austerity, and further disappointment with privatization, Greece should flare up again as an issue in late-2013. Post-German election, however, Merkel will have the necessary political capital to shove it under the proverbial carpet.

U.S. Stocks: What Now?

The U.S. stock market is becoming fully valued, with the market trading at 14.5 times forward earnings.

US Stocks, What Now?

True, corporate earnings are still good and could get even better in the months ahead, especially if global economic conditions improve and the dollar’s appreciation takes a pause. But over the longer run, corporate profit growth will inevitably gravitate toward nominal GDP growth, which should be around 4-5%per annum.

Expected returns in U.S. common stocks should be around 6% (with a dividend yield of 2%). Anything above this expected return should be considered excessive, and would rely on continued multiples expansion. Such expansion remains possible, but will depend on the interaction between the U.S. economy and Federal Reserve policy. Any increase in interest rate expectations may not be conducive for a continued upward re-rating of equity multiples.

Bottom Line: The risk-reward trade-off in U.S. stocks is less appealing now that equity prices are in the fair-value range. We are comfortable with our neutral stance for now.