Greek Election Update
It’s 2am in Athens and results are still coming in. It is clear that Syriza has won a historic victory, but it is, as yet, unclear whether it will achieve an outright majority. The nation that invented drama has not disappointed: estimates put Syriza on 149-151 seats, with 151 seats required for an outright majority. This is going down to the wire.
The unequivocal success of Alexis Tsipras’ party at the polls suggests that, even if he falls one or two seats short of an outright victory, he is likely to go down the coalition route, rather than opting not to do so with the aim of securing an outright majority at a second election. A further factor here is the likelihood that far-right Golden Dawn will be the third placed party – extraordinary not least due to the fact that a number of senior members of this party (including party leader, Michaloliakos) are currently residing in prison. The mechanical process whereby the second and third placed parties are asked to form a coalition if the winning party either cannot, or will not do so, is an eventuality that the Greek political establishment will wish to avoid. This suggests that Syriza will choose to enter into a coalition and that potential coalition partners will be more amenable. After all, Tsipras – given the size of the Syriza vote – has his choice of partners, and the rhetoric has been noticeably toned down by party representatives today, suggesting this is indeed the strategy, as well as making it easier for potential partners to enter into discussions. If he fails to achieve a parliamentary majority, Tsipras will have three days to try to form a coalition. The odds have to be that he will do so. So it looks almost certain that a new government will be formed this time around with Syriza in the driving seat.
Interestingly, it doesn’t look like Papandreou will succeed in achieving representation. This effectively removes a coalition partner that might have proven problematic further down the line (please see my previous article, ‘Mind the GAP‘). Indeed, the only thing Papandreou appears to have achieved by going solo is to split the PASOK vote, thus, in all probability, helping Golden Dawn to third place. The most likely coalition partner for Syriza is probably the ‘Independent Greeks’ (ANEL) who, somewhat surprisingly, look to have taken around 13 seats. On the face of it, this is an extraordinary pairing, with ANEL right of centre and Syriza, staunchly to the left. The common ground is the fact that both are ‘populist’ parties, and ANEL appears to espouse a number of policies that Tsipras must feel he can work with: it has in the past stated that it rejects the bail-out agreement and has additionally promised to bring to book those who have abused their position for financial gain. Tsipras probably believes that this choice of coalition partner is the one likely to ensure he has free rein to implement his radical agenda. So even in the case Syriza do not achieve an outright majority, a coalition in which ANEL is the only partner would not, in my view, be a significantly better outcome in terms of the equity market. It is worth noting, however, that Tsipras is set to meet Stavros Theodorakis, leader of Potami, tomorrow, underlying the fact that we cannot as yet be definitive regarding the composition of any coalition (though Syriza yesterday ruled out working with PASOK, whom it holds partly responsible for Greece signing up to the bailout agreement).
To recap, Tsipras has promised to: a) reignite economic growth; b) cut unemployment; c) cut taxes; d) increase pensions; and e) punish those in the establishment who abused their position for their own financial gain. As far as the implementation of a strategy to achieve the economic targets are concerned, there has been little or no detail. Indeed, listening to Tsipras you would be forgiven if you imagined you were in the presence of a Soviet apparatchik describing a five year economic plan; we have left the world of economics as we know it and entered the realm of fantasy. More worryingly, Tsipras has additionally said that he will not be bound by the terms of the bail-out agreement with Greece’s Troika of creditors and will seek a significant write-down in the nominal value of outstanding debt. He has also threatened to prolong negotiations with the Troika until July, leading to speculation as to whether he means to honour Greece’s debt obligations during the intervening period. Is all this mere bluster, or should we take him at his word?
There are two basic scenarios, the first of which runs along optimistic lines: Tsipras, having gained power, will tone down his demands, some slight concession will be made by the Troika (lengthening of payment terms, rather than debt forgiveness) and the terms of the bail-out agreement will be broadly adhered to. The historical precedent here is the smart about-face executed by Andreas Papandreou who, when he came to power in 1981, abandoned the anti-NATO, anti-Europe rhetoric on which he had campaigned and proved himself to be a pragmatic centrist. The second scenario has two strands and a common upshot. a) Tsipras, under pressure from the 30% or so of his own party who are hardline leftists has no choice but to honour his election promises; b) Tsipras actually turns out to be an idealist and fervently seeks to pursue his election promises. Whichever of these two strands proves to be true, the upshot is the same in both: a showdown with the Troika in which Greece is issued with an ultimatum: ‘adhere to the bail-out terms, or exit the Eurozone’.
So which of the two opposing scenarios is more likely? Unfortunately, for reasons discussed in previous articles in this series (cf ‘Grexit or Grin‘ and ‘Grexit Polls‘), in my opinion we are looking at the second scenario – showdown with the Troika. For what it’s worth, having witnessed a number of Tsipras’ campaign speeches, I consider him an idealist. This makes him more unpredictable and less likely to agree to a face-saving compromise. Nothing short of a substantial debt write-down and a free hand to implement his pro-growth agenda is likely to satisfy him; whereas, the compromise he will most probably be offered by the Troika is unlikely to go much beyond a lengthening of maturities and some slight concession that would allow Tsipras to claim he had reduced the severity of the bail-out terms. In this instance, Tsipras will, in all probability, reject the offer and an impasse will be reached. This accords with my central case scenario discussed in previous posts. However, with Tsipras now either in possession of a parliamentary majority, or at the very least in coalition with a minor party, the safety valve that would have existed if Syriza were in coalition with a centrist party (such as Potami or PASOK) is no longer present. Given ANEL’s policies – which look distinctly euro-sceptic – they might well back Tsipras in a call for a referendum. This opens the way for other outcomes.
Since I find it difficult to believe that Greece will simply be forced out of the Euro without its populace having a say in the matter, I believe that even if Greece is in technical default (i.e having missed one or more of its debt repayments in H1) at the time that an impasse is reached this would not automatically be grounds for ejection from the Eurozone. However, an ultimatum from the Troika would likely require that Greece recommit to the terms of the bail-out agreement and make good on any missed debt repayments. At this point, I would expect Tsipras to call for a referendum. The wording of such will tie continued Eurozone membership into adherence with the austerity programme and a commitment to honour outstanding debt. Given the widespread anger at the bail-out measures and resentment towards the Troika on the one hand, and the desire of the majority of Greeks to remain in the Euro on the other, this is likely to be a close call. Consequently, tail end events are likely to be accorded a greater probability during this period, resulting in significant market volatility.
My central case remains that, faced with a referendum (even one worded in such a manner), the Greeks will choose to stay in the Euro. At this point, the Tsipras government might fall, possibly triggering new elections. Any newly elected government, or, alternatively, newly mandated Tsipras government, will resume debt repayments and abide by austerity measures, and the crisis will be over. Needless to say a ‘No’ vote in the referendum would mean Greece exits the Eurozone, defaults on its debt, and goes back to the drachma. Whilst the recently announced ECB QE should, I think, prevent panic spreading to the rest of the periphery, there would undoubtedly be a short period of heightened volatility in global equity markets. The Greek equity market would be decimated.
It is worth enquiring into whether it is likely Tsipras’ request for debt forgiveness might actually be acceded to by Greece’s creditors. Certainly, there has been some noise around this topic in the media, with a few commentators, principally from the groves of academe, putting forward such a suggestion. Whilst interesting in theory, the cold reality of the situation is that writing off a portion of the outstanding debt would involve lenders wearing a significant loss, given the c. EUR 245bn in Greek sovereign debt held by the EFSF and the ECB (with a further c.EUR 25bn held by the IMF and around EUR50bn held by the private sector). Not only would a write-off of a sizeable chunk of the debt held by the EFSF/ECB, for example, be very difficult to countenance from a political standpoint for certain key players in Europe (i.e Germany), it would also be seen as setting a dangerous precedent: Tsipras has not disguised the fact that he sees himself as the ideological leader of the left-leaning populist parties within Europe, and has made much of his links with Pablo Iglesias, founder of the Spanish left-wing party, Podemos (who actually appeared on the podium with Tsipras at one point in the latter’s election campaign). Acceding to Tsipras’ demands will inevitably lead to similar demands from populist parties in Spain (c.EUR 1tn public debt) and later, perhaps, Italy (c.EUR 2tn public debt). Not only are the sums involved simply too large to absorb without materially impacting the fiscal position of the more robust Eurozone members, writing off debt would effectively remove any incentive for structural reform. And the periphery in general, and Greece in particular, is in chronic need of such reforms if it is ever to show sustainable real GDP growth. So a meaningful debt write-off is most likely off the table. As discussed, Tsipras will probably be offered a maturity extension and a cut in the (already ultra low interest rate), but this, I think, is unlikely to satisfy him. As described above, once this stage is reached the probability of a tail end event rises.
So what of our theoretical trading strategy? As a reminder, the worst case outcome from a (Greek) equity market perspective is an outright Syriza majority. As far as a possible coalition with ANEL goes, this, in my opinion, is little better. Consequently, the strategy remains to go short Greek equities, focused on the banks. The issue is one of timing. It is not impossible that the market initially rallies on the Syriza victory. Such a rally could be driven by three factors: 1) the belief that Tsipras will about-turn on his election promises and seek a face-saving compromise with the Troika; 2) the belief that the prospect of participation in ECB QE will prove to be a carrot sufficient to tone down Tsipras’ demands (and its reciprocal – exclusion from Eurozone QE – a sufficiently large stick to give Tsipras pause for thought); and 3) if in coalition, the view that the presence of a coalition partner may act as a safety valve that might help reduce the risk of an extreme outcome. Any such rally should, however, be faded as, in my assessment, Tsipras is likely to soon show himself as an idealist on a mission to change Europe. Unfortunately, Tsipras’ messianic belief is centred on the sort of heavy-handed interventionist policies that typify much of the leftist economic philosophy, the upshot of which is usually a series of boom-bust cycles, increased government share of GDP and a stifling of free entreprise. Their final result is stagflation. And more debt. This would clearly be a regressive step in a wider European context. As discussed, I don’t believe a coalition partner such as ANEL will offer the safety valve that had been hoped for; indeed, Syriza and ANEL will most likely find themselves in broad agreement with their desire to take on the Troika. A coalition between Syriza and Potami would offer the hope that the referendum scenario could be avoided.
In conclusion, the probability of a Greek exit from the Euro is now meaningfully higher: under Tsipras’ leadership – assuming that Syriza either achieves an outright majority, or, alternatively, enters coalition with one of the small parties, most likely ANEL – Greece will probably, some time in the next six months, come dangerously close to leaving the currency union. There will most likely be significant volatility in Greek equities (focused on the banks) as the market lurches between viewing Tsipras as a pragmatist on the one hand, and a dangerous idealist on the other. As time passes, the latter view is likely to become increasingly prevalent, dependent on what sort of policies he enacts in Greece (some of which may well appear ‘market unfriendly’) and how he comes across in his negotiations with the Troika.
On this latter point, Tsipras will likely play for time, doing his best to drag out negotiations and raising the spectre of technical default as the months pass and repayment dates loom. The longer the negotiations take, the greater the probability of an impasse. Once stalemate is reached, our theoretical trading strategy would call for the maximum short position to be in place; in my opinion, Tsipras will not back down of his own volition and this will pave the way for the exit scenario to manifest. Needless to say – given my belief that the Greeks will ultimately choose to remain within the Euro, in spite of the sacrifices that must be made to ensure continued membership – shorts should be closed before the result of a referendum is known. Alternatively, in the case of a Syriza-Potami coalition, it would be advisable to close shorts as soon as the idea of a referendum is put forward by Tsipras (I would expect Potami to reject this, triggering a collapse in the coalition). However, as the market fully factors in the ‘Grexit’ scenario, there should be ample return from the short trade.
As such, any market rally should be used as an opportunity to establish shorts at a higher level, allowing more scope for resizing on the way down. Of course, if no relief rally is forthcoming, then initial short positions should be instituted immediately. If the election result triggers an initial sell-off in the broader European equity market, I would expect this to prove temporary and, as such, this would represent a buying opportunity, ECB QE having in effect created a firewall ring-fencing Greece from the rest of the Eurozone.
Please see Disclaimer.