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The Strategic Outlook |
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Strategic Group · 4380 SW Macadam Ave, Suite 260 Portland, OR 97239 · (503) 222-9737 · www.InvestwithStrategic.com · May |
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Strategic Group’s e-update |
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It’s hard to imagine how a country the size of Alabama with a population the size of Michigan could cause such an upheaval in the market. If you watched any news on May 6th, you saw or heard about the Flash Crash. The Dow was down about 1000 points and back up 600 points in a matter of minutes. Some said a “fat-fingered trade” was part of the problem while others blamed technology, but the only real issue being discussed before the fall was – Greece. As a side note, while being interviewed on television, Jeffrey Immelt, the CEO of General Electric, said multinational companies have not been concerned with Greece in the last thousand years. Then why are we concerned about Greece now?
Answer, the possibility that the financial problems of Greece will snowball into a global slow down that will stall the economic recovery. Backing up a bit, the GDP of Greece was estimated at $341 billion for 2009 compared to an estimated $14.26 trillion in the United States for the same period (roughly 2%). With its deficit running at 14% of GDP, the IMF would like Greece to reduce it to 3% within the next few years. Since they can’t print more money like the U.S., they must find a way to collect more taxes and/or reduce expenses. Obviously, this could slow their fragile economy more than desired if they choose the wrong path. If they were able to leave the Euro zone and print their own currency, they might decide on a different solution. Defaulting or restructuring their debt might be possible if they weren’t part of the Euro, but as a member nation, their economic health has an impact on the Union as a whole. The fear then is that Greece’s financial problems will spread through other Euro zone countries like a row of dominos because of a wide-spread excess of sovereign debt.
Whether you’re talking about Greece, Portugal, Spain, California, or the United States, the problem is that debt burdens for sovereign entities have reached alarming levels. A state or country in such a position doesn’t have to default to cause concern in the market. A default would affect those holding the debt of the sovereign entity, but the fix could also have detrimental affects on the global recovery. In the case of Greece, Portugal, and Spain, the requirements for assistance from the International Monetary Fund are austerity plans. Benefits have to be cut back and taxes have to be raised. Both actions take money out of the hands of consumers to pay down debt, which in turn slows down growth.
If they were able to restructure their debt, or pay creditors less than owed, it would be felt by banks throughout Europe. The banks would have to take big losses, which in turn would probably require more capital infusions to maintain status quo. Furthermore, investors would demand higher interest rates on government debt to a point that they would have to restructure again, starting the cycle over. Regardless of the method decided, Greece will have to cut spending and increase taxes, something that is never popular and very difficult to sell to the public!
On a positive note, the macroeconomic indicators for the US appear to be improving. But is Greece a canary in the mine warning of future problems to come? Some of the citizens of Greece rioted when faced with salary and pension cuts and an increase in the Value Added Tax. And while it is easy to chalk it up to the emotional temperament of the Greek people, it wasn’t so long ago that students in California staged protests over tuition increases. The addiction to government programs and tax credits is not easily solved. While Greece had an estimated 113.4% of debt to GDP in 2009, the United States had 52.9%. At some point, we too will need to address runaway spending, and while it is tempting to tax the other guy (Measure 66 and 67), statistically the higher the tax rates the greater the incentive for tax evasion/avoidance.
Greece is known for having a large underground economy. Greeks reportedly talk openly about avoiding taxes. We have seen estimates that 25-30% of their GDP is in an underground economy – people not paying taxes on income. The inequity of the tax structure will need to be addressed if Greece is to avoid default. The same tax structure inequity might also be said about the United States where reportedly 47% of the population doesn’t pay federal income taxes. So, from that perspective, the US and Greece share three problems: debt, tax inequality, and an addiction to government spending.
Investment Outlook During the first week in May, we rode out the downturn because we believed a short-term pull-back was overdue and exiting and re-entering during a short-term correction results in additional trading fees and some lost opportunities on the re-entry. While Greece is admittedly a concern, there was no new bad news. In fact, the outlook appeared more positive than in the previous few months. The Greek parliament had passed the austerity measures and France and Germany were prepared to provide assistance. The European Central Bank has shown itself to be committed to providing assistance to Greece though slow to communicate their plans.
Going forward: Although a small correction was anticipated, after the “Flash Crash,” the market has exhibited an uncomfortable level of volatility. This may have been caused by the trading glitch or could have its roots in a deeper more pronounced problem. While we picked strong companies and feel many have long-term growth potential, we are reducing exposure in certain securities based on the irrational trading activity. We prefer not to anticipate market down turns; however, we remain committed to preserving capital as a goal. Should the economic data, sovereign debt concerns, irrational market, or other issues as yet unknown change our outlook, we will make changes in the portfolios to mitigate risk.
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Statistical data source www.cia.gov/library/publications/the-world-factbook/geos/gr.html |
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Greece Fire |