As we write, it appears that more than 75% of the holders of privately held Greek bonds have accepted the deal to exchange old bonds for new, and that the eventual acceptance rate could go over 90%. For the U.S. stock market, this may take the Greek situation off the table temporarily, allowing investors to turn their attention, instead, to the rapidly declining EU economy, continuing sub-par growth in the U.S. and the gathering global slowdown.
The Greek government will announce the final tally at 1:00 AM Eastern Standard Time Friday. At that time it probably will activate the clause that enables them to force all holdouts to accept the deal. Under the terms of the agreement holders will accept a cut of 53.5% in face value of the old bonds as well as a sharply lower interest rate. The goal is to reduce Greek debt from the current 165% of GDP to 120% by 2020.
The action does not mean that we’ve seen an end to the turmoil. The Greek economy has been in recession for five years and the current unemployment rate is over 20%. The required severe austerity measures make it almost certain that the Greek economy will continue to contract and that the budget deficit could get even worse, threatening the nation’s ability to meet payments even on the reduced amount of debt. Already, the new bonds to be issued are selling at huge discounts to face value on the so-called grey market, meaning that the chances of another default are high. We also note that elections are coming up soon that could result in new leadership inclined to pander to an upset public facing higher unemployment, lower wages and cuts in pensions
Moreover, the deal still leaves the EU economy in bad shape. The ECB said that the EU economy is likely to contract this year, marking the third consecutive quarter that they have revised down their growth rate. German manufacturing orders in January fell for the fifth time in seven months while Spanish industrial production has been in a steep decline. Consumption and exports have generally been falling throughout Europe. The implementation of austerity is likely to make things even worse.
The bulls believe that the European problems are not a threat to the U.S. or global economies. They point out that the decline of Japan in the 1990s did not prevent the rest of the world from prospering. Unfortunately, however, this is no longer the 1990s, when the emergence of the desk-top computer and the internet triggered a world-wide boom. Now, U.S. economic growth is sluggish while China, Brazil, India, Russia and South Africa are all slowing down at the same time. China has officially reduced its 2012 growth target, and India’s fourth quarter growth rate was its lowest in two years. Brazil’s economy grew at 2.7% in 2011, half the rate originally forecast. China’s exports to Europe are slowing as are China’s own imports of commodities. China is the largest trade partner of Brazil and most of the other nations primarily dependent on commodities exports.
In our view, the U.S. will not remain an oasis of tranquility in a world that is either slowing down or already in recession. The stock market is already overbought and overvalued at a time when earnings estimates are being revised down. The odds of a significant downturn remain high.