Greek Crisis Map: Three moving parts of the investment universe

This analysis of the three moving parts of the investment universe is a prelude to four investment scenarios for a Greek exit from the Eurozone. Each of the three moving parts: politics, economic cycle and asset valuations are graded from 1 (no worries) to 10 (maximum concern) to show the current risks involved. This analysis forms part of a Greek Crisis Map.

1. Political environment – Politics is the main driving force behind macroeconomic changes. It is policy moves – for better or for worse – that create new market paradigms. In the latter category, think of the second Quantitative Easing launch by Federal Reserve Chairman Ben Bernanke at Jackson Hole in August 2010 and the Long-Term Refinancing Operation introduced by the European Central Bank in December last year. Again, these were all denial-phase responses to the initial crisis caused by the imploding credit bubble – as politicians and central bankers alike told us that they have the solutions: fiscal compacts, firewalls, emergency lending etc. In reality these are all merely different flavours of the same thing i.e. solving a solvency crisis with liquidity. Ironically these very solutions have only exacerbated the underlying issue: too much debt. We are fast reaching the end game, where empty pockets and no further mandate for fiscal or monetary stimulus mean that politicians are being thrown out of office. In the EU, Germany is at a crossroads where it must decide: pay now by opening up its balance sheet or pay later as it finds itself isolated and with an impossible strong currency relative to its neighbours. Grade 8
   
2. Underlying economic environment – European unemployment is at a record high of 10.9 percent and youth unemployment is at 22 percent, and for Spain alone it is above 50 percent. Consensus growth for Europe in 2012 is -0.4 percent versus +2.3 percent for the US and +2.3 percent for the world. Grade: 10
   
3. Valuation. The stock market is wrongly used as a barometer for the overall economy and risk. During this era of central banks forcing liquidity into the economy and maintaining a zero-interest-rate-policy, the stock market is a particularly misleading indicator. In the denial phase and in the early stages of the protest phase, the market rose due to the combined action of fiscal stimulus and monetary expansion. Now, some major markets are only down 5-10 percent from their peak. Grade 5

The good news is that when both the underlying economic and political situation is close to an all-time low, things can’t get much worse! It also means there’s a high probability that the four or so years of the first two crisis phases are drawing to a close. I see the final phase lasting 6-18 months, after which we will find ourselves in an environment of lower leverage, lending, and much less public sector involvement. What happens between now and the other side of this phase is the key question. The main hope must be that we find the solution along the way: restarting our economies by relying on the individual and his/her ability to act rationally.