SEI Investment Management Unit
Commentary
June 18, 2012
Greek Election Results—The Relief Is Temporary
The Greek elections reduce the danger of a near-term exit by Greece from the eurozone (EMU), but there has been
no change to the bigger picture. The cycles of panic, policy actions, relief, and more panic will continue.
Europe‟s recession is in danger of deepening due to capital flight and banks‟ growing risk aversion. Hopes of a grand
policy gesture will likely be disappointed.
We still have a negative view of the euro and believe U.S. stock markets remain a better bet than most other
developed markets.
A eurozone-friendly outcome in this past weekend‟s Greek
elections merely puts off the eventual day of reckoning, as
the country‟s two basic problems remain unchanged:
It cannot pay back its debt under any conceivable
scenario without debt forgiveness and/or fiscal transfers
from other eurozone countries.
It cannot improve its competitive position in the confines
of the currency union without severe downward
adjustments to economic output and incomes.
As long as Greece remains in the eurozone, growth of its
gross domestic product (GDP) will be negative for some
time, which could increase its already sky-high
unemployment rate and contribute to further political
upheaval. Of the five political parties that won the largest
share of the vote, only one—the communist KKE—currently
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advocates abandoning the euro and restoring the drachma.
Most polls indicate that a majority of Greek citizens want to
remain in the eurozone. However, we continue to believe
that Greece will eventually have no choice but to depart the
single currency union.
Implications for Europe
For the eurozone as a whole, Spain and Italy remain the
biggest threats, as they are simply too big to save should a
worst case scenario come to pass. More bank and debt
guarantees and even massive outright fiscal transfers would
be needed, but it remains to be seen how far Germany and
the other creditor nations will bend.
The current funding mechanisms designed to backstop
eurozone government debt, the EFSF and ESM, do not
have even half the firepower needed to rescue Greece,
Portugal, Spain and Italy. Proposals to grant the ESM a
banking charter in order to leverage its capital would
technically solve this problem, but also create a whole
new set of risks.
Data from the European Central Bank (ECB) and
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national central banks show that investors and
depositors have been pulling financial capital out of the
financial systems of periphery nations in earnest over
the past twelve months. While the resulting imbalances
are not a serious problem in normal times, in a worst
case breakup scenario, they would have to be netted out
between national central banks, and it is not clear that
periphery central banks would have the necessary
resources to make their counterparts whole. If they do
not, then a breakup could be rather messy, and
taxpayers in core nations would be forced to absorb
significant financial losses.
Clearly, no eurozone country is likely to escape
unscathed should the euro project fall apart. Such an
outcome would mark Europe‟s „Lehman moment,‟ and
would also be reminiscent of the Asian financial crises of
1997, when a large number of national currencies
experienced devaluations and extreme volatility. Of
course, the eurozone crisis is unique, especially in light
of its complex private, sovereign and supra-sovereign
entanglements and the region‟s tradition of generous
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1
“Greece poll: Pro-bailout party‟s narrow win hailed,” BBC, 18 June 2012,
< http://www.bbc.co.uk/news/world-europe-18482415> , accessed
6/18/2012.
EMU nations have central banks that can be thought of as „branches‟
of the ECB. This structure is somewhat similar to the U.S. Federal
Reserve system, which has 12 regional Federal Reserve Districts,
each with its own Federal Reserve Bank, that report to the Federal
Reserve Board of Governors in Washington, D.C.
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© 2012 SEI
FOR FINANCIAL INTERMEDIARY USE ONLY. NOT FOR PUBLIC DISTRIBUTION.
entitlement systems, so this story will continue to have its
own twists and turns. At the very least, we would expect
capital controls to be implemented with the possibility of
countless financial assets remaining frozen for months if not
years—events that would act as an additional drag to a
region already struggling with recession.
As noted in previous commentaries, ultimately, the ECB is
the only entity capable of backstopping the entire EMU
financial system, and it has already crossed the Rubicon of
balance-sheet expansion. However, those efforts are
meeting with increasingly limited success, as shown in
Exhibit 1. The money multiplier, which can be thought of as
the ratio of broad money, including that created through
economic and financial activities, to money created only by
the central bank, has been falling precipitously since 2011.
Similar to the U.S. in the wake of the 2008 financial crisis,
the normal transmission mechanisms through which central
bank actions impact the real economy are not functioning
like they used to. Thus, ECB policy actions are unlikely to be
as supportive of economic activity as they once were. It‟s
also important to keep in mind that supporting economic
activity is not part of the ECB‟s official mandate—it is
charged only with keeping the overall price level stable.
Exhibit 1: A Sinking Money Multiplier
Exhibit 2: Slipping Into Recession?
Our View
We continue to hold a negative view on the euro and are
still cautious on equities despite yields on safe haven
fixed-income securities falling to record lows. As noted in
a recent commentary (“Big Divergences, Still Looking for
a Catalyst,” May 2012), we have yet to identify sufficient
catalysts for a durable rebound. Thus, we expect
markets to remain news-driven and volatile for the
balance of the year. We are still relatively optimistic
about the U.S. economy as exports to the EMU account
for only about one percent of U.S. GDP (two to three
percent for the broader European Union). As a result, we
believe U.S. equities will remain a better bet for investors
than international stock markets for the foreseeable
future.
Our Funds
As a result, there has been eurozone-wide deterioration in
economic activity, as shown in Exhibit 2.
Industrial
production is falling, and purchasing manager surveys
indicate this is likely to continue. Unfortunately, we believe
this could persist for some time.
The SIT International Fixed Income Fund remains
overweight Financials, but managers have continued to
pare those positions with the intention of putting the
proceeds back to work if and when spreads in certain
sectors approach their highs of late 2011. Our
international and global equity funds continue to have
minimal direct exposure to Greece, and as shown in
Exhibit 3, remain underweight the Financials sector.
Exhibit 3: Fund Allocations to Financials Sector
Fund
Weight
(%)
Benchmark
SIT
MSCI EAFE
International
15.37
(Net)(USD)
Equity
SIIT
MSCI EAFE
International
15.42
(Net)(USD)
Equity
SIIT World
MSCI All Country
18.66
Equity ex-US
World ex-US
SIMT Global
MSCI World
Managed
6.13
(Net)(Hedged,
Volatility
USD)
Sources: BlackRock, SEI
Month-end weights as of 31 May 2012
Weight
(%)
Difference
21.91
-6.54
21.91
-6.49
23.41
-4.75
18.31
-12.18
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© 2012 SEI
As shown in Exhibit 4, though slightly overweight to the
stocks of eurozone-based companies, the SIT International
Equity Fund continues to have minimal direct exposure to
Greece and is underweight Italy and Spain.
Exhibit 4: SIT International Equity Fund EMU Exposure
Country
Fund (%)
Benchmark (%)
Difference
Netherlands
3.76
2.41
1.35
Belgium
1.84
1.04
0.80
France
9.25
8.88
0.37
Ireland
0.56
0.28
0.28
Germany
8.39
8.33
0.06
Greece
0.06
0.07
-0.01
Portugal
0.05
0.2
-0.15
Austria
0.01
0.24
-0.23
Finland
0.53
0.79
-0.26
Spain
1.62
2.56
-0.94
Italy
1.05
2.11
Sources: BlackRock, SEI
Month-end weights as of 31 May 2012
Benchmark is MSCI EAFE Index (Net)(USD).
-1.06
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© 2012 SEI
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© 2012 SEI