A modern Greek tragedy
In the last year, the birthplace of Western civilization has received a lot of attention on its economy – notably its debt. As the Greek debt crisis escalates again, Great Britain prepares to vote on a potential exit from the Eurozone. So what have we learnt from Greece and how can you protect your portfolio in these volatile times?
The Greek debt crisis
To avoid defaulting on its debt, Greece needed to repay 1.6 billion Euros in loans to the International Monetary Fund (IMF) by 30 June 2015. At the time, many investors believed that an eleventh hour deal would be done, but the Prime Minister stunned the world by calling for a referendum encouraging the nation to vote against the reforms, which included raising taxes and cutting government pensions to pay off debt. The resounding ‘no’ result increased odds that Greece would leave the Eurozone because without funding from the IMF and European Central Bank, they effectively needed to create their own currency in order to fund ongoing liabilities.
The effect of uncertainty
With a population of nearly 11 million accounting for only a small contribution to Europe’s GDP, the impact on global markets should have been negligible. However, investors were more concerned about the potential tail risks of a Greek exit from the Eurozone, or ‘Grexit’ as commentators labelled it. With the debt crisis once again escalating as the nation faces default (if it fails to receive the loans needed to cover its maturing debt in July), Greece’s government is dragging its feet on implementing the unpopular economic reforms demanded by its creditors. In addition to its crippling debts, Greece is also in the middle of the migrant crisis, which has made recent economic recovery a huge challenge. The uncertainty following a 'yes' vote to Britain leaving the European Union (EU) would undoubtedly put further pressure on Greece’s cash-strapped economy.
The impact on global markets
Given the unprecedented nature of such an event, the financial, economic and geopolitical consequences from the exit of any EU member are unknown. It is this type of uncertainty that rattles investor nerves and poses many unanswered questions: - What would this mean for other debt-laden countries? How long would such a process take and how would an exit be managed? Will other European countries follow suit? These unanswered questions sparked investor fears and contributed to the global fall in market values last year, and now – twelve months on – it is Great Britain going to the polls on 23 June 2016 to decide whether they too should leave or remain in the EU.
What it all means for investors
Just as we saw with Greece, the upcoming Great Britain referendum is creating significant uncertainty for investors. In fact, given the area is a more significant economic zone than Greece, if Great Britain decides to leave the EU then it has the potential to generate global equity market volatility as it would need to renegotiate trade deals with the EU and set appropriate immigration, regulation and fiscal policies.
Economists have modelled a wide variety of scenarios and believe that the economic impact of leaving will be minimal if the eventual trade deal and immigration policy are similar to present settings. However, if policy settings become more inward looking it could be negative for growth. Further, a ‘Brexit’ might create precedent for other countries and regions to also leave, which could lead to a complete break-up of the Union. As such, a leave vote is likely to cause significant financial market volatility and uncertainty, as well as a lower British pound and potential appreciation in the AUD.
At present, polls are very tight, showing that approximately 45 per cent of respondents wish to remain in the EU, 42 per cent wish to leave and 13 per cent are undecided1. However, as was shown with the Scottish referendum in 2014, polls are not a reliable indicator of the referendum result. In that case, the polls were relatively even ahead of time, however the ‘no’ side won with 55 per cent of the vote on the day. If you instead look at betting markets, which tend to be reliable indicators of outcomes, staying in the EU is a $1.36 favourite against leaving at $3.00, implying approximately a 74 per cent chance of staying2.
Protecting your portfolio in volatile conditions
Diversification is an integral part of any portfolio and what Greece has taught us is how quickly markets can become volatile. As investors it is important to understand that no particular investment consistently outperforms others and for this reason, investing into a range of asset classes can counter underperformance in another, thereby reducing the overall risk of your portfolio.
When uncertainty spreads through global equity markets, history suggests that investors rally to safe haven assets such as gold, government bonds and property. Another factor to consider, which often gets forgotten in a declining market, is the relevance of having cash within a portfolio. Despite cash rates and term deposits being at historical lows, the current environment highlights why cash is such a valuable asset. In times of panic, cash becomes increasingly relevant as opportunities arise, something which is often forgotten when equity markets are rising.
While volatility has already begun to increase within financial markets given the current uncertain global economic outlook, it’s still worth reviewing your portfolio and re-evaluating how well protected it is should conditions deteriorate significantly. This is important as the gains earned over the previous few years may have made some investors complacent as to the true risks inherent within their investment portfolios.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.