Grexit or Grin?

Greek Elections: Is it Time to Buy or Sell Greek Stocks?

So the Greeks failed to elect a President, triggering a mandatory general election which is to take place on January 25th 2015. Where now?

To begin. Published polls are pretty unanimous in pointing to a Syriza win, albeit with a fairly tight margin. However, in order for Syriza to form a majority government, they need to get a minimum of 37% of the vote – this would give Syriza a parliamentary majority thanks to the automatic award of 50 seats that is given to the first placed party in the polls (technically 40% is required, equivalent to 101 seats out of the available 250 seats that are decided on the basis of proportional representation; however, this tends to be lower, depending on the % of the vote given to parties that don’t achieve representation – i.e., get <3% of the vote). So one scenario is that Syiza wins, but takes < the required 37% of the vote; in this instance, it could not form a parliamentary majority and would have to seek coalition partners.

Let’s further examine this scenario. Of the potential coalition partners, the Communist Part of Greece (KKE/c.6% of vote estimated) has already ruled out forming an alliance with Syriza, and Syriza has ruled out working with the far-right Golden Dawn (with around 6% of the vote).

Of the smaller parties, there are 2 possible coalition partners – the Independent Greeks (ANEL) and the Democratic Left (DIMAR). However, the latter is unlikely to get the 3% of the vote required to achieve representation and the share of the former won’t be enough in its own right to determine the next government (though it could feasibly play a minor role in any grand coalition).

This leaves 3 other parties – New Democracy (the incumbent government), Pasok (partner of the current government/around 4% of the vote) and Potami (c.6% of the vote). Theoretically, both Pasok and Potami (with perhaps 10% of the vote between them) could choose to form a coalition with Syriza. In terms of numbers – and ignoring swing voters for now – the polls suggest that Syriza alone could take around 27.5% of the vote vs just over 24% for the incumbent party. Clearly, in this instance were Pasok and Potami to choose to form a coalition with Syriza then their c.10% of the vote would just about take Syriza over the required 37% to form a government (perhaps increasing to 39% were there to be a grand coalition with Potami, Pasok and ANEL).

However, much depends on how the swing vote goes: 12-13% of the electorate categorise themselves as ‘undecided’. A good showing for Syriza amongst this group could mean that, to form a coalition, perhaps only one partner would be required, either Pasok or Potami. There is obviously a higher probability of forming a coalition with one, rather than two (or even three) parties. It is difficult to say which way these swing voters will jump; anecdotally, ideological voters (who tend to be older and owners of assets) that might have been expected to vote for Syriza are concerned about the implications of a possible Syriza victory; whereas, younger voters (probably unemployed and asset-light) are likely to feel they have little to lose – the way these two dynamics play out is impossible to call.

Next we must ask, what demands will any coalition partner(s) make in return for sharing power with Syriza? Both Potami and Pasok have stated that they are committed to staying in the Eurozone. And herein lies the rub. Syriza has also said that it wants to stay in the Euro, but additionally has promised to renegotiate the terms imposed by the Troika (the trio of Greece’s lenders, comprising the IMF, the European Commission and the ECB). As far as the Troika is concerned, these two concepts – i.e. continued Greek membership of the Eurozone and a material easing of the terms of compliance (which is to say, a scrapping of the current austerity measures) – are mutually exclusive. To the obvious question ‘What happens if the Troika says No to your attempts to renegotiate terms?’ Syriza thus far has no answer. However – and this is important – the fact that Syriza has not provided a convincing answer to this question does not mean that either Potami or Pasok will refuse to form a coalition; indeed, in a 3-way coalition all parties would be agreed on their desire to remain within the Eurozone, even if Syriza would have a major ideological difference of opinion regarding the terms on which continued membership should be based. And perhaps the coalition partners might think that it is worth letting a Syriza-led government try to renegotiate such terms; after all, they may consider that there is a small chance that Syriza could succeed in gaining some sort of concession…

Let us summarise: 1) the most probable scenario is that Syriza is first placed in the election and is asked to form a government; 2) that it is unlikely to get an outright majority – i.e. gathers less than 37% of the vote – and thus forms a coalition with either Pasok or Potami, or both; 3) the Syriza-led government subsequently attempts to renegotiate terms with the Troika; 4) in all probability this attempt is unsuccessful, triggering political instability; at this stage, Syriza could seek to call a referendum on remaining within the Eurozone on the current terms (a very different matter to a referendum regarding continued membership of the Eurozone in the abstract). At this point, it is likely that any coalition would fall apart because the coalition partners could not countenance such a direct threat to continued Eurozone membership (i.e. the chance that the referendum decides against continued membership), to which they are committed. This would then trigger a second general election a few months later.

Stages three and four are likely to be accompanied by high market volatility as the market raises the probability of tail-end scenarios – ie, Grexit – coming to pass.

What chance Syriza only makes a show of trying to negotiate with the Troika, thus paying lip service to the election promise and most likely granting itself greater longevity as the ruling party? The story I have heard of late, with a worrying frequency, is that Syriza’s leader, Tsipras, will ‘do a Papandreou’, who, having campaigned on an anti-NATO, anti-Europe ticket in the early 1980s, subsequently did an about-face when he actually got into power. This, I believe, is a complacent reading of the situation for two reasons; 1) 30% of Syriza is ideologically far-left, absolutely committed to renegotiating terms and will not be appeased with half-measures (Andreas Papandreou was in absolute control of his party); and 2) Nothing is known of Tsipras and we cannot predict with any degree of certainty how he might react in a given situation (Papandreou was a middle-class intellectual, a Professor of Economics educated in Europe and N. America). So, I think it more sensible to assume that a Syriza-led government will embark on strenuous attempts to renegotiate the bailout terms, as they have promised.

There are two other possibilities to consider: firstly, Syriza might take a high enough share of the swing vote so that it gets the required 37% of the total vote and can thus form an outright majority. From the perspective of market volatility, this is the worst scenario, as it will give Tsipras absolute freedom of action, the first result of which is likely to be a game of brinksmanship with the Troika. Secondly, assuming the answer is, as expected, no meaningful renegotiation, this may trigger an actual referendum on Greek Eurozone membership (contingent on the current austerity policies). Whilst we know that an overwhelming majority of Greeks want to remain in the Euro, the majority also view the current austerity measures as unreasonable – hence the popularity of Syriza’s anti-austerity stance. So such a referendum could be a close call. Alternatively, Syriza may try to prolong negotiations past the date where a bond repayment comes due, perhaps triggering a situation whereby Greece is in technical default. An attempt to force an easing of terms in such a manner – i.e., by holding up the spectre of carnage in the sovereign bond market – is equally unlikely to succeed, with an ultimatum from the Troika likely met by domestic political pressure in Greece that would, most probably, result in a similarly-worded referendum, with all the risks that this entails.

I would highlight in passing that any sovereign QE in the Eurozone (which, in the opinion of this writer will be announced in Q1 2015) would make a possible Greek exit infinitely more manageable from the perspective of containment of the accompanying market disruption. Conversely, this may mean the market is much more focused on the real possibility of a ‘Grexit’, leading to higher volatility. I should also clarify that, in the absence of such sovereign QE in Europe, I would expect significant downside to equity markets, with contagion spreading to other countries in the periphery. As said, this latter is not my central case and my bullish stance on markets for 2015 is predicated on either a) Greece remaining in the Eurozone or b) that any Greek exit could be managed from a market perspective thanks to sovereign QE (which should shore up bond markets in the rest of the periphery) and the simultaneous provision of massive liquidity by the ECB.

The second possibility is an outright win by the incumbent party; this cannot be ruled out given 1) a gap in the polls of c.3% between New Democracy and Syriza (a gap which has been narrowing over the last 12 months or so) and 2) the fact that 12-13% of voters are currently undecided. As discussed, this latter group will be confronted by conflicting emotions as the possibility of a Syriza victory – and all this might bring – becomes real. They may well decide that it is a case of better the devil you know, despite the self-serving mediocrity that, unfortunately, afflicts much of the current political establishment.

In the absence of the second scenario – a surprise victory for the incumbents – the outlook for the Greek stock market is ultimately negative. This may be intensified by domestic measures enacted by Syriza that would appear very market unfriendly; these range from raising of (the already punitive) wealth taxes to, let’s say, a more focused targeting of the ‘rich’ (definition: any household earning more than EUR50k pa pre-tax). I should also mention that Syriza has, in the past, threatened to nationalise the banks…

The micro implications? Since >30% of the Greek stock market is comprised of banks – and these are reliant on implicit ECB guarantees – this is obviously where volatility will manifest. In spite of the poor performance of the Greek banks in 2014 – driven in the first instance by fears over the outcome of AQR/Stress Tests (ironically, and in spite of NPLs remaining stubbornly high in the mid 30%s, these failed to reveal any methodological issues or major capital shortfalls) and latterly by political risk – there would almost certainly be significant further downside to share prices as the market raises the probability of a tail end event.

Equally, if New Democracy pulls off a surprise victory on the 25th, there would appear to be significant upside to share prices for the Greek banks – think 50%+ (with Eurobank and Piraeus being the higher beta names).

It should be noted that if Syriza can only form a government by means of a coalition, then share prices might actually stage a relief rally on the ‘Papandreou’ comparison; however, I would be looking to go short into any such strength, believing that such a reading of the situation is misguided. Such a short position should then be closed after the probable rejection by the Troika of any attempt to renegotiate terms and the (probable) subsequent call by Syriza for a referendum on continued Euro membership – this event probably marking the nadir in sentiment – and, following this, the likely collapse of the coalition.

So, theoretically, an actionable strategy would run as follows: a) outright Syriza win – overwhelmingly negative, instigate short positions in the Greek banks; b) surprise New Democracy victory – outright positive, instigate long positions in the Greek banks; c) Syriza win, but forms coalition government – go tactically long any relief rally (on the ‘Papandreou’ comparison) but instigate shorts before negotiations with the Troika begin; however, if the market falls rather than rallies, immediately instigate shorts. Note: if scenarios a) or c) transpire and sovereign QE is not forthcoming in Europe (or is categorically ruled out), I would look at shorting the wider periphery on contagion fears.

Speaking as someone with a personal interest in Greece, I very much hope – without in any way wishing to gloss over the very real plight that is facing large swathes of Greek society, in particular the younger generation – that it is a case of GR-IN (and bear it), rather than GR-EXIT; I think both Europe and Greece will, ultimately, be the stronger for it.

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2 thoughts on “Grexit or Grin?

  1. Scott Evans says:

    Thanks for this excellent analysis of the political situation. Quick question for you – how realistic do you think today’s commentary (5th Jan 2015) that Germany is “preparing” for a Greek exit? Also the contagion or lack of contagion that seems to be the consensus now – what’s you view?


    • Thanks for your comment!

      Good questions. The claim made in Der Spiegel article (3rd Jan: ‘Bundesregierung hält Ausschieden Griechenlands aus dem Euro für verkraftbar’) – that Germany is preparing for a Greek exit from the Euro and believes such an event to be manageable – has been officially met with a ‘no comment’ from Berlin, so we should probably conclude that it is indeed true. The timing of the article is clearly of interest, and I think it should prove helpful in driving home to the Greek electorate that electing Syriza is likely to put Greece on a path whereby the probability of an exit from the Euro is considerably raised. Furthermore, it should hopefully help dispel the idea, popular in certain quarters in Greece, that a Greek exit cannot be managed from a technical perspective; it is undoubtedly partially thanks to this idea that Tspiras senses there is leverage to materially renegotiate terms.

      On the lack of contagion thus far to the rest of the periphery – as evidenced by moves in govt bond yields – then I think we must perhaps look to an increasingly-accepted view (in the market, at least) that sovereign QE in Europe will be forthcoming. As you imply, previous fears of ‘Grexit’ (e.g in 2012) also meaningfully impacted bond yields in the rest of the periphery. As I commented in my article, if this proves to be false and QE in Europe is explicitly ruled out or the market changes its view on the probability of such, then I would expected bond yields in the rest of the periphery to start blowing out if Syriza win and subsequently embark on a game of brinksmanship with the Troika (as they will in all likelihood do).


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