Plato said that courage is knowing what not to fear and that wisdom is knowing what to fear.
So should we fear the Greek financial crisis or have the courage to shrug it off and look it as an opportunity to take more risk as fear becomes more prevalent?
There's a lot of conjecture about what the situation in Greece means for Europe specifically and the global economy more generally.
While I wasn’t in the camp of those who thought the subprime mortgage issues would be contained, many investors were, and most famously, so was former Federal Reserve Chair Ben S. Bernanke.
That's not surprising as our illustrious Fed chairs don’t have very good track records when it comes to economic forecasting. Alan Greenspan was an atrocious economic prognosticator and Janet Yellen isn’t anything to write home about.
Everything that happened in subprime took place on a smaller scale in manufactured-housing lending in the late 1990s and the results were devastating.
We were a large player in that industry at that time so we had a front-row seat to the excesses building up but exited before the carnage took place.
Those problems were truly contained since it was such a small part of the economy, somewhat akin to Greece today.
Subprime was so significant to the domestic and ultimately global economy that contagion was a clear and present danger at the time for those willing to look at the situation objectively.
Risk Signals to Watch
As it's been said, markets tend to go up like an escalator and drop like an elevator. Everyone is naturally nervous when bad news is pervasive. It can be hard to determine whether to exit the crowded theater first at the risk of missing a great movie.
The first step is to determine whether the theater is crowded and how much risk people are exposed to. Are investments held by weak players without the staying power, either emotionally or financially, to withstand a downturn? Lacking emotional fortitude can lead to short-term panic moves that are disconnected from the fundamentals and allow more confident actors to step in and monetize the opportunity.
If hordes of investors have to sell because they have obligations they need to fulfill then that can be a different story. This can lead to a widespread loss of wealth that can feed on itself as collateral values become impaired and more selling is required. This typically necessitates large Fed or government involved to stop the bloodletting.
There is a lot to worry about. China has had a debt-fueled infrastructure and real estate explosion that really has very little parallel in history. The Mideast is in the early stages of what could be a multi-decade civil war between Shias and Sunnis with Syria and Iraq as the epicenter. Lower energy prices are not without their negative effect on oil-producing countries.
Emerging markets are very exposed to dollar-denominated debt that can get a lot more expensive to service and repay should the dollar continue appreciating. And the recovery in the U.S. seems to be very uneven with very weak GDP in the last quarter and lackluster manufacturing data.
So what is an investor to do?
My first course of action is to look at market prices to see if they may be signaling anything.
Ten-year Treasury yields peaked in the most recent cycle at 2.49 percent, dropped to 2.33 percent when Greece imploded and now they're back up to 2.42 percent, as of this writing.
The 2015 low was 1.68 percent, so I see bond market investors not very concerned about economic weakness. They’re looking through the data and challenges to a reasonably good economy. The technical picture seems to support this as well.
Lumber prices are also up quite a bit from their May lows when they reached approximately $233. Now they're closer to $300. With that being said, however, the technical pattern looks like one of lower highs and lower lows so this is a question mark.
The housing market seems to be finding its footing so this could support lumber prices and is bullish for the economy. Copper prices seem to be putting in a bottom so this is constructive for economic prospects.
Finally, another indicator I like to track is the spread between Baa corporate yields and AAA yields to see how investors are pricing credit risk. Although it's up about 50 basis points from one year ago, it's also down about 50 basis points from 2012 when there were similar worries going on. I’m not seeing signals of major caution yet.
Europe might be a different story though. Although Greece is a very small player relatively speaking, the market seems to have more concerns about its impact.
I looked at Euribor, which is like Libor, but the price of lending euros between banks for different time periods as opposed to dollars. For banks to borrow overnight from each other the rate has been between -0.00172% and -0.00179% (yes, that is approximately negative 17 basis points) between May 2015 and June 29.
On June 30, however, the rate increased by becoming less negative to -0.00106%. This is a very big 7 basis point move in one day which means that banks are becoming a bit more nervous to lend to one another in euros in Europe.
There could be more fireworks to come in Europe. U.S. dollar Libor has hardly moved during this time as a comparison, speaking once again to fewer concerns about the U.S. banking system, which of course is a good thing.
It goes without saying that market indicators can change so applying one's own analysis is very important as well. But from my reading of the tea leaves it seems like staying the course in the U.S. makes sense while treading very carefully in Europe is the way to proceed.
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