By a Thread: The Ongoing Greek Drama
June 18, 2012

All eyes have been on Greece this weekend, but the outcome will not settle the ongoing Greek Drama. For investors globally, the election in the Hellenic Republic was widely seen as a vote on Greece’s ongoing membership in the Eurozone, but the result will change nothing with Greece remaining on drip-feed by the rest of Europe. Early indications are somewhat better than initially hoped for with New Democracy winning 30 percent of the vote and 130 seats in the 300-seat legislature with socialist Pasok receiving 12.5 percent of the vote. But only a conclusive victory by either the anti-austerity Syriza party or the pro-Europe New Democracy party would have even a faint hope of calming nervous markets.

Investors have been cautiously optimistic in recent days, as private polls have shown that the pro-European party, New Democracy, was the leading party heading into Sunday’s election. Even leftist party Syriza softened its stand heading into the election in the hope of doubling the 16.8 percent of the vote it captured at an inconclusive election on May 6th. Syriza’s charismatic leader, Alexis Tsipras, has called for a reversal of the deep cuts in pensions and the minimum wage, raising unemployment benefits and preserving public sector jobs—to be financed by soaking the rich. This populist message resonated with angry voters as Greece endures a fifth year of recession with cumulative output losses approaching 20 percent.

But Sunday's election results have done little to settle the score on Greece’s euro membership, as the New Democracy party will still need to form a governing coalition and then approach the troika—the EU, IMF and ECB—for yet even more talks. With recent polls indicating that at least 75 percent of Greeks favor remaining in the Eurozone and angry mobs hitting the streets, the new coalition government will need to at least try to renegotiate the terms of the existing bailout packages.

The only way that speculation over Greece’s future in the Eurozone could have diminished is if Greece was either relieved of its remaining debt altogether, achieved a balanced primary budget or the Eurozone was amended in such a way as to include some form of debt mutualization amongst Eurozone member countries. Even if Greece could balance its books, the country is not self-sufficient in either food or energy, making a go-it-alone strategy virtually impossible. With Germany holding firm, refusing to consider Eurobonds or amend the terms of the previous bailout packages, the possibility of debt mutualization or forgiveness wouldn't see the light of day. Just last week, German chancellor Angela Merkel reiterated her long held view that Germany was not going to guarantee the debts of its partners but instead will push for sweeping new rules for a political and fiscal union within Europe.

With the Greek situation continuing to hang over markets for months to come, investors are likely to remain skittish. It was just a week ago that Spanish Prime Minister, Mariano Rajoy, was boasting that a EU agreement to provide up to €100 billion in aid for his country’s banks was a triumph that had adverted a full-scale bailout of Spain . Almost immediately, bond investors remained skeptical of Rajoy's claims sending 10-year Spanish yields briefly above seven percent, a figure that in the past has triggered full-scale bailouts in Greece, Ireland and Portugal . And while Greece may be garnering all of the attention lately, Spain remains the pink elephant in the room. If bond markets continue to remain inhospitable to Spain, a sovereign bailout and further market turmoil aren’t far behind. As I mentioned on CNBC the other week, Spain could be the next Lehman Brothers—shaking markets to the core.

Recently, investors have been betting that central banks will feel compelled to stimulate their economies, to prevent further economic stagnation. But with Sunday's inconclusive elections, the Fed is unlikely to move to quell investors’ angst by engaging in further unsterilized QE. The Fed will likely hint of further measures at its Wednesday meeting, but there is scant evidence that monetary policy has real firepower left, with rates already so low.

For commodities, particularly gold, QE1 and QE2 were manna from heaven, helping to boost metals prices, largely because they were unsterilized and added to the money base. But the Fed's most recent attempt to stimulate the economy, Operation Twist, which had no measurable impact on money supply, left metal prices out in the cold. Unless hell is reigning down in Europe , the Fed is unlikely to interject itself in the American election campaign and will likely remain on the sidelines for now.

Investors are likely in for a constant drip, drip of negative news out of Europe, which will lead markets lower. Investors should continue to build cash balances, high-grade their investment portfolios or consider becoming active on the short side of the market. With the risks skewed toward the downside, investors are urged to be safe, rather than sorry.

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