What a Potential Greek Exit Means for Investors

The threat of contagion presents one of the best arguments for keeping Greece in the eurozone and holding it to its fiscal commitments. If Greece gets relief from existing fiscal commitments, or if it exits the euro, it could set a precedent for others to follow—something that contributors to bailout funds aren't likely to want. Banks in "core" countries such as France and Germany have large exposures to Spanish and Italian debt, and a Greek exit could send yields on Spanish and Italian government debt to unaffordable levels. Additionally, a further worsening of the Spanish economy and housing market could result in private sector loan losses for banks both inside and outside of Spain, in particular on already distressed mortgages and property developer loans.

Potential contagion exposure among German, French, UK, and US banks

Source: Bank for International Settlements, April 2012. Holdings as of 12/31/11.

What are the implications for investors?

This new stage of the eurozone debt crisis presents downside risks to global growth prospects, an increased likelihood of market turmoil, and the possibility for European stocks to underperform.

As a general rule, markets hate uncertainty, and there's a lot of it in Europe right now. This uncertainty, combined with contagion fears, is pressuring European economic growth. Additionally, the eurozone is large and intricately linked to other economies through trade and the banking system. In the United States, where total exports only represent 14% of GDP,¹ we may be slightly more insulated from the effects of the eurozone debt crisis—but future corporate profits could be reduced nonetheless.

Because most of the major tools to stem the crisis have political and legal barriers, we believe more market turmoil is likely before they are enacted. For the time being, we expect a continuation of the same rollercoaster loop: markets riot (peripheral stock and bond markets fall), policymakers react, markets sigh relief, policymakers relax (either timeliness or strictness toward austerity and progress toward solutions), and then markets riot again.

European stocks are likely to experience bouts of volatility over the next year or longer. As the potential for downside risks and the likelihood of high levels of ongoing volatility have both increased, we prefer underweighting Europe at this time. We realize there could be rallies in European assets, but believe there is an unfavorable risk/reward profile, and prefer a defensive US asset allocation for developed market exposure. Over the intermediate term, we have a positive view toward both a diversified emerging market equity allocation and toward the Chinese equity market. An underweight in international stocks overall is likely appropriate at this time. The degree to which you adjust your portfolio will depend on your individual investment strategy and asset allocation, which depends on your risk tolerance and time horizon.

1. U.S. Department of Commerce, Bureau of Economic Analysis, data for 1Q 2012 as of 4/27/12.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Diversification strategies do not assure a profit and do not protect against losses in declining markets.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.