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Twin Debt Default Prospects Temper Stock Market Advance

Late drama in the bond world put the brakes on an already tepid stock market gain in the 1st half of 2015. As the calendars roll forward into July 1st, the prospect of an outright default in Greece and Puerto Rico is being reported by various news outlets as being imminent and ominous. Looking at each we will briefly handicap where we go from here:

Greece

  • European Central Bank actions and European bank credit default spreads would indicate that both policymakers and the markets believe that Greece’s problems spreading to Europe or beyond is unlikely at this time.
  • A Greek default is likely to be a tragedy for the Greek people but should not be a big enough event to derail signs of a synchronized global upturn – e,g. U.S. consumer spending is picking up, stronger Eurozone GDP, China’s decision to ease, etc.
  • At the margin, global central banks (including the Fed) are likely to remain easier for longer until more clarity is achieved.
  • The likelihood of a bank run and capital controls has both major political ramifications for Greece’s political system and potentially geopolitical ramifications for Europe (i.e. NATO) as a whole.
  • The existential threats to the Euro are no different today than they were a week ago. Ultimately, Greece is making a political rather than an economic decision to pursue such a hard line with its creditors.

Puerto Rico

  • On Monday, June 29th the governor of Puerto Rico warned that the US territory could not pay its $72 billion public debt burden.
  • While certain individual investors may find themselves exposed to potential losses as Puerto Rico restructures, we do not see this as a systemic risk event, nor as a bellwether of potential crises elsewhere in the US municipal debt market.
  • The island isn’t eligible to declare bankruptcy, as it’s a commonwealth rather than a municipality. As such, the situation has become messy for its creditors, which include major US mutual funds.

Debt levels of Greece and Puerto Rico are unsustainable and have been for a long time. The fact that the situation has arrived at these respective inflection points should not be of surprise to investors who have been paying attention to the news or the financials of either Greece or Puerto Rico. Our viewpoint is that a haircut on the debt levels is all but unavoidable, and has been the ultimate end game since the financial crisis of 2008/2009. Only leniency, central bank intervention and low interest rates have allowed the situation to go on this long. While not minimizing the economic and societal negative impacts that have and will likely continue to occur, it is our belief that the overall global economic framework will be little disrupted by these two unrelated, but parallel events. Puerto Rico has an annual GDP of ~$100 billion and Greece ~$242 billion. As a comparison the bank JP Morgan has a “GDP” of nearly $240 billion and the city of Minneapolis’ GDP is ~$280 billion. The ultimate outcome for both these events is almost entirely politically-driven, so investors should not risk buying into the debt of the two crises, trying to time the purchase of perceived undervalued assets.

Greece 10-Year Yields


David M. Kirkpatrick, CFP®
SVP, Portfolio Manager

Charles A. Williams, CFP®,CTFA®
SVP, Portfolio Manager

Brian A. Barker, CFP®, AIF®
SVP, Director of Asset Management