Greece is on the ropes. It now carries the world's worst credit rating and scores of economists now say default is inevitable. Greece has received bailouts from the International Monetary Fund and the European Union. Now its neighbors are footing the bill because it's unclear how far-reaching the effects of a Greek default could be.
"I think in the near term, the odds are you're not going to see a default," says Russ Koesterich, chief global investment strategist at iShares. "There is a very concerted effort to push any credit event out until about 2013, if possible. That doesn't mean they're actually going to get there, but that's what officials are trying to do at this point."
The problem with trying to predict Greece's future and the future of the European Union is that there are so many parties involved. The Greek government has agreed to initiate more austerity programs to cut down its massive debt, but with more cuts come more protests in the streets of Athens and political cooperation on austerity plans needed to assure further aid is anything but certain. The money that's already being lent to Greece came from the tax dollars of some of the wealthier countries in the core of Europe like Germany. Citizens of other European nations are becoming fed up as well. "If you think markets are hard to forecast, political outcomes are really hard to forecast," says Steve Wood, chief market strategist, Russell Investments North America.
Economists are especially concerned about exactly what a Greek default would mean for banks around the European community, including the European Central Bank—Europe's version of the Federal Reserve—that hold a significant amount of Greek debt. And there are worries about contagion—or the idea the default could spread to the other indebted members of the so-called PIIGS countries, which include Portugal, Ireland, Italy, and, most importantly, Spain. "The one that is too big to fail would be Spain," Wood says.
Whether or not Greece defaults over the summer is nearly impossible to predict, but experts say there are a few developments that every investor should brace for:
More volatility. The most common measure of volatility is the Chicago Board Options Exchange Volatility Index (VIX), which uses options prices to measure expected volatility in the S&P 500 over a 30-day period. It's often referred to as the "fear gauge" because it measures how fearful or complacent investors are at any given time. This year, the VIX peaked around 31 in March after the earthquake in Japan, but it recently hit lows not seen since the last bull market in mid-2007. The VIX closed at 14.69 on April 21, the lowest level since July 2007, according to TrimTabs Investment Research. Koesterich says over the last 20 years, the VIX has generally traded in near 20, on average. Lately, the VIX has traded above 20. "Stocks are going to be volatile this summer," he says. He advises investors to take a more defensive position in stocks, in sectors such as healthcare and telecommunications that generally aren't as tied to economic fluctuations rather than more cyclical stocks like retailers who rely on the strength of the consumer.
Most importantly, says Robert Tipp, chief investment strategist for Prudential Fixed Income, don't try to trade on the news. "Investors don't want to find themselves selling at the bottom and buying at the top in reaction to the headlines," he says.
Boost for safe haven assets. With higher volatility generally comes a flight to what are perceived to be the safest assets, such as the U.S. dollar and treasuries. As the Federal Reserve ends its second round of quantitative easing, in which it's buying $600 billion worth of treasury securities to push interest rates lower, many experts have questioned who would step in to buy these same assets at historically low yields. Now as the European sovereign debt crisis is heating up again, experts say rattled investors will probably take refuge in the treasury market. "Despite all the concerns about U.S. sovereign debt … if investors are risk-averse, you're going to see some flight to quality into the dollar and treasuries, which means despite the deficit, rates stay low for longer," Koesterich says. On Monday, the 10-year treasury closed just below 3 percent.