The Eurozone’s ongoing drama, especially the possibility that Greece might begin the end of the European currency union, is top of mind for many. In this post, I will describe our professional assessment of the situation, the protections we have in place in your portfolio if you are a client of our firm, and the actions we will take to protect you if the situation further deteriorates.

If you are not a client of our firm, this professional summary is still very relevant to you. It is unbiased, and should help you assess the size of the risk you are now facing. It also describes the way a globally diversified portfolio protects you from depending on guesses about the future.

Summary of the Situation

The European situation is very complex and has added volatility to the global market, which always causes concern.

The crisis has three main elements.

First, some European governments, especially Greece, Ireland, Italy, Spain and Portugal, are close to being unable or unwilling to keep up with their promised debt payments.

Second, one way to default is to leave the currency union and print a new, but less valuable, currency to pay off their existing debts. This kind of backdoor default would likely create spill-over effects—contagion—that could sink other, weaker EU member countries.

Third, European banks are large holders of sovereign debt so if there are government defaults, there will be a banking crisis.  The European Central Bank has been providing short-term relief for banks, but many of those financial institutions’ long-term solvency is in question.

In some ways, what European nations are facing is similar to what we dealt with in the US just a few years ago. Taxpayers (and fiscally solvent nations like Germany) are being put upon to bailout failing institutions, and given the interlinked financial system, risks are huge. Additionally, similar to what we faced here, the situation has become as much political as economic.

Greece – the Canary in the Currency Union’s coal mine

Greece’s current ratio of gross debt to GDP is around 160%. Spain’s debt ratio is 60% and Norway’s is more like 25%.

In March, in order to avoid a default, Greece conducted a bond swap with private creditors and its bond values fell precipitously. To date, the Greek government has done little more than take more than US$300 billion in bailouts from the IMF and the EU combined, and promise to reduce debt to 120.5% of GDP by 2020.

A run-off poll on June 17^th of this year elected enough members of the pro-bailout parties to form a parliamentary majority, but it’s unclear whether the new government will be able to earn back the credibility necessary to lower borrowing costs.

Assessing the Risk & Taking Action

Your mutual fund manager, Dimensional Fund Advisors, has determined that Greece may lose its status as a developed market, and has suspended all equity purchases in Greece.

However, in global terms, Greece’s economy is very small. According to the IMF, it ranks 42^nd, below Chile and above the Czech Republic.

Even during the good times Greece’s publicly traded companies represented roughly 0.25% of your globally diversified equity portfolio.

Greek bonds have never qualified for Dimensional’s bond strategies, so you don’t own any.  Nor do you own debt issued by the other EU members. 

One way to measure the actual uncertainty in the markets is the Volatility Index, or VIX, sometimes known as the “fear index”. The VIX shows the market’s current estimate of the near-term future volatility of the US equity market. As you can see, European uncertainty has elevated volatility at times during the past year, but it has been nowhere near its peak reached around Lehman Brothers’ collapse in 2008.

Dimensional is closely watching the European situation and continues to review the status of Greece and other EU countries and make appropriate adjustments to your portfolio.

Conclusion

The European situation is very complex and continuously evolving. While it may seem headed towards an obvious outcome, it is a bad idea to base your investment strategy on recent headlines, because everything known publicly has already been priced into the market.

Basing investment choices on speculative forecasts has been shown, time and again, to be a faulty strategy.

We understand that you might be anxious or concerned about future events. It challenges confidence to see countries like Greece face financial uncertainty. And in a global economy Europe’s problems are, to a lesser extent, our problems.

However, change is constant, and we, just like you, cannot possibly know what the eventual outcome will be. We are also confident that your financial plans are still on track.

Rather than invest and act based on what you see in the media, we encourage you to stay the course of your own financial plan, which was developed with your goals and needs in mind.

Our steadfast investment philosophy allows for market ups and downs, and no corrective action is called for at this time.

Remember that the U.S. survived its financial crisis and although there was a chilling bear market in late 2008 and early 2009, investors who stayed the course recovered along with the market.  And investors who continued to save and invest ended up having the opportunity to buys stocks at great prices.

We cannot predict the future any better than the next Nostradamus wannabe except to say based on two centuries of experience, the creativity, innovation, and entrepreneurial energy of seven billion people makes the global equity market the best place to seek long-term returns.

We’re always happy to hear from you, so if you have further questions or just want to check in, give us a call!

Okay, I admit it. The photo is of Barry Bonds and the article is about Treasury Bonds. Come on, though, can’t a finance gal have a little fun on a Friday??

And now for more fun, I have exciting news! Today the ten-year Treasury Bond yield fell below 1.5% for the first time since, well for most of us, forever. Gone are the good ol’ days of the 1980s when you could put on your legwarmers and lock into a sure double digit return by lending money to Uncle Sam.

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