Over the past couple of weeks, Europe has been back in the headlines, as Greece’s inability to form a government and other signs of political revolt against austerity led to a sell-off in global stock markets. Greek voters rejected the two incumbent parties in a preliminary election, opting for smaller extremist parties.
This past weekend, the Greek anti-bailout party Syriza said it would not take part in a coalition government to help put austerity measures into place. It is likely that this whole Greek tragedy will result inGreece exiting the euro zone and facing economic collapse.
To put the Greek situation in proper perspective, Greece makes up less than 3% of Europe’s economy, and China can grow the economic equivalent of Greece every four months. Greek economic collapse in and of itself is not a significant threat to the global economy.
The greater threat is the spreading revolt against the Germany-advocated plan for European austerity and fiscal responsibility. This can lead larger economies such as Spain and Italy to default on their debt and leave the euro zone.
I think the crisis would be contained in Greece, and after seeing the economic consequences Greece is about to suffer, other EU members would be more willing to comply with Germany and reduce spending.
In the short run, the ECB can continue to lend money to European banks to buy more sovereign debt and prolong the status quo. In the long run, the euro will likely lose value against other currencies and much of southern Europe will be stuck in a Japan-like long-term economic slump. Meanwhile, Germany, Netherlands, and other nations in northern Europe will continue to muddle along with slow growth.
Looking at the tape, it is clear that bears have the upper hand right now. In down-trending markets, the stock market usually opens higher and sells off throughout the day to close near the lows. That has been the dominant trading pattern this week. Investors should wait until market close to buy stocks, instead of buying near the open.
Although I still believe that we will see a new high later this year, likely in Q4, the deterioration in market psychology is expanding the downside trading range. I think the downside is limited to 1270 on the S&P 500, around where we started the year. With the Europe overhang, it will probably be another lazy and sluggish summer for global stock markets.