Looking Forward: What's next for Greece Equity Index?

Spanish version published in Serenity Markets

The idea of this work is to compare the evolution of the European Equity Indices, with a focus on Greece, with the behavior experienced by the Indices of the Countries that had a Sovereign Default experience in the past. In particular, for this analysis we are going to use Russia, Indonesia and Argentina.

First of all, we are going to take a look at the evolution of the Greece Equity Index since its last peak occurred in January 2010 and compare it with the one performed by the other Indices in the past.

As we can see in the following graph, Greece Equity Index is now at a lower level than the bottom point of the Indonesian Equity Index after the default of its Debt in 1998 and at the same levels of Argentinean Index after its default in 2001, with a loss of more than 75 percent points (p.p.). However, the Russian Index decreased by 94 p.p. after the 1998 crisis, 14 p.p. less than the bottom level of Greece Index.

Equity Indices – Historical evolution

The immediate question is, what’s next for Greece? Is going to follow the Argentinean path, with a recovery in the Equity Index level in 22 weeks (almost half of the downside period), or would be the Russian path, with a deeper drop and a slow recovery along a five years period? On the other hand, Indonesia showed a fast recovery and then a double dip. Despite the way and the period, these three countries recovered together and almost at the same time after 2002, in part because of same changes in the global economy.

Equity Indices – Behavior after the bottom

Which one is the most likely scenario for Greece? What changed after 2002 that made these countries recover the pre-crisis levels in their Equity Indices? To determine this we are going to find the principal drivers that changed its trend after the 2002 and helped these countries to leave the crisis behind.

The first driver was the World GDP. As we can see in the next graph, between the beginning of the crisis in Russia and Indonesia and going through theirs and Argentinean Indices bottom points, the World GDP remained almost flat, with a cumulative growth of 6% between 1997 and 2001. On the other hand, the recovery of the three of these countries occurred between 2002 and 2004 in a scenario of 27% of World GDP growth.

World GDP at current prices

The future scenario for the World GDP looks more like the one of the end of the 20th century than the one of the beginning of the 21st century. If we take a look at the three biggest economies, we find that United States is facing a declining on its growth or at least troubles to recover the growing path, the Euro Area is coming from a slowdown in the last year that looks more like to becoming into a recession than into a recovery and finally the growth in China is definitely below the 10% last century mean.

So, as regards to this driver, the future of the Greece Index looks more like to be characterized for a couple of years of a slow recovery, maybe after a deeper drop, than for a fast one.

The second one, more than a driver was a common characteristic of these three countries, and it was a devaluation on their currency exchange rate of about 75%, with the corresponding improvement in their international competitiveness and the effect of the imports substitution. It is important to mention that the currency devaluation was a characteristic of the start and bottom period of the crisis than of the recovery.

Indices Evolution and Exchange currency rates

The devaluation of the exchange rate seems to be a necessary condition for the recovery of the Economy, or at least it was for most of the countries with debt problems in the past.

It is important to remark that devaluation would have a big impact on Greece GDP. One important part of Greece GDP is tourism. In 2001, before Greece had entered into the Eurozone below a common currency (EURO), the exports of travel services had represented almost 50% of the services exports and more than 30% of total exports, however at the end of 2011 these ratios were 33% and 21% respectively.

It is clear that with devaluation there is a good margin for that activity to increase, Mykonos is going to be cheaper than Barcelona for European tourists for example, been a good start for the Greece economy recovery in general. To put this in perspective, Argentinean exports/GDP ratio before devaluation was 11%, for Russia 25% and for Indonesia 26%. This ratio for Greece is around 24%.

However this Monetary Policy instrument is not available for Greece and the other members of the Euro Zone. Furthermore, the decision of devalued the currency for Greece includes an exit of the Euro Zone, which implies more difficult issues than just devaluation.

On the other hand, a devaluation most of the times come with a drop in the Equity Index, so if Greece is going to need a devaluation of its currency, or in this case an exit from the Euro Zone, the impact of this decision in the Index is going to be big, putting it into a lower level.

Just like the first one, the second driver direction point into a lower level scenario for Greece Index.

The third driver is the commodities prices, this variable is important because the exports of commodities in these countries represent more than 30% of the total exports. In particular for Russia the crude oil and the oil products represents more than 50%, for Argentina the primary products together with the energy ones sum around 35% and lastly for Indonesia the products related to the mining activity account 30%.

The following graph shows the evolution of the commodity prices indices and we can see how the agricultural and energy commodities showed an increase in its prices of 43% and 61% respectively between 2002-2004, while the ones related to the industrial minerals rose 28%, with the corresponding increase of 40% for Argentina and 80% for Russia and Indonesia in the exports of these products.

Commodity Price Indices Evolution

For its part, Greece Oil exports represent 30% of total exports of goods and 13% of total exports, so in some sense we can expect an impact of this driver on Greece economy but maybe not as big as the one saw in the other countries.

Since the crisis in Greece started to present, the oil price was in an upward trend and trading in a range between 100 and 120 US dollars per barrel, closer to the peak price of 2008 than to the historical average prices. However there is a chance the oil price to go back to the historical maximum (QEIII), the scenario is completely the opposite of the previous crisis because commodities in general and oil in particular were in historical minimums.

Like the first two, the last driver doesn’t look like to be on the Greece side neither.

Conclusions

In this paper we follow the evolution of the Equity Indices of the biggest sovereign defaults in the contemporary history, Russia, Indonesia and Argentina, to evaluate the beginning, deepening and recovery of these countries.

To do it, we used three different drivers, the World GDP growth, the depreciation of the currency exchange rate and the commodities prices, to explain the recovery of the indices of these countries. Once we had the drivers, we use them to evaluate the Greece’s actual situation in order to forecast which one is the next step of the Greece Index. The projections of these drivers are not good news for Greece,

Firstly, the World GDP seems not likely to channel a growing trend of around 30% like it did in the beginning of the last century, instead is showing signs of weakness or even recession in some of the more important economies.

Secondly, at least for now, devaluation is not an isolated decision for Greece like it was for the other countries, it also means an exit from the European Union with uncertain consequences not only for Greece economy but also for the world in general, with a possible negative impact into the first driver, the World GDP.

Lastly, unlike the scenario faced by the other countries 10 years ago, the commodity prices are near the historical maximum levels and, unless they keep breaking maximums and combine with a scenario of a slowdown in the global economy, the more likely direction is down.

In conclusion, all the factors analyzed in this work, point that the Greece Equity Index is likely to be in the bottom zone than in the recovery one, with more chances of hit a lower level or face a slow recovery during a long period (Russian path) than follow the Argentinean path, with a fast recovery coming.