Greece is NOT a “Black Swan Event”
In the now-famous words of Nassim Taleb, the bankruptcy of Lehman Brothers was a true black swan event. What I mean by this is that the bankruptcy of Lehman Brothers was unforeseen by markets, and thus, unprepared for. Let’s take a look at charts of Lehman Brothers bonds to illustrate the point.
These 2 bonds dropped 90% and 94%, respectively, between 9/9/08 and 9/18/08, or nine days. This is the definition of a black swan event, as the market clearly did not discount any risk of default whatsoever, and then the bonds of Lehman swan dived extraordinarily as soon as the market realized they were broke. The reason for this is that investors assumed the government would bail out Lehman as they did Bear Sterns in the JP Morgan takeover, but, in the end, this did not occur.
Let’s now take a look at a chart of a Greek government bond to compare.
While the Greek bonds have certainly not performed well, they are down 55% over the last year and a half. This indicates the market’s orderly repricing of Greek government risk. While it is true that a sudden default announcement would send these bonds plummeting toward zero, the more likely case of a debt restructuring would probably not have a huge effect on these bonds. The haircut scenarios being discussed have Greek bondholders receiving 50 to 70 cents on the dollar for their bonds, which is what the bonds are currently trading at. While this will constitute a default, we do not believe that a Greek default would trigger an outright financial collapse as it did with Lehman.
Lehman Brothers’ bankruptcy triggered a run on bonds of all natures. The thought was, if Lehman could go, then literally anyone could. AIG, GE, Goldman… in the fall of 2008, pretty much any US corporation was liable to go bankrupt at any time. Moreover, the amount of credit default swaps and collateralized debt obligations that were backed by these investment corporations were not even quantifiable. In the world of interrelated synthetic bond obligations and huge derivative counterparty exposure, a $1 billion default could trigger $20 billion of defaults through CDO’s and other structured products. With such a huge amount of counterparty risk that was impossible to identify and size up, the fear of the market knew no bounds.
The Greek situation is far different. The market has had a full year and a half to digest Greek’s debt problems, and has accordingly repriced Greek debt each step of the way. In our opinion, an orderly default of Greek debt would not constitute an event nearly as debilitating as Lehman Brothers. Bondholders knowing what they’re going to get on the new bonds is far more reassuring than the chaos following Lehman, and the ECB will package the deal in such a way that Ireland and Portugal have some measure of protection against the Greek contagion, possibly a partial guarantee of those countries’ debts or a similar workout.
To be sure, the situation is going to get uglier. We believe a Greek default, coupled with a run on the euro, is inevitable, with the euro trading down to the 1.2-1.3 range. However, after the initial shock wears off, the market should quickly realize that not only is the rest of the world not going to fall apart because of this, equities in the rest of the world have already been beaten down to bargain prices. As it stands, high-quality companies like Google and Apple trade at 18.6x and 15.7x earnings, respectively. With a stock market that has already priced in slowing fundamentals and a good deal of downside, we believe that the risk asset markets will recover quickly even if they face initial pressure due to Greek default.
We believe commodity markets could also experience the same type of initial shock followed by recovery. While silver and other industrial metals could experience headwinds due to fears of global industrial slowing, gold should shine. With the extreme loss of confidence that is about to occur in the euro, the dollar and gold should be beneficiaries.
For subscribers who have already heeded our recommendations to purchase gold in the recent past, consider purchasing more, but cautiously. We believe the gold bull market will last for at least 1-2 more years, and as such, a gradual building of the position is key. If gold falls more, it is critical to have more cash on the sidelines with which to add to positions.
ALL INFORMATION INCLUDED HEREIN IS THE OPINION OF THE FIRM AND SHOULD NOT BE CONSIDERED INVESTMENT ADVICE. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.