Don’t bet on a European resolution


By David Llewellyn-Smith

Over the past few weeks, as equity markets around the world have awoken to the renewed dangers of Greece by falling 4% to 5%, there’s been a growing chorus among the usual bullish suspects to buy the dip. Over the weekend, this line of thinking received some heavy duty support in the form of Jonathon Wilmot at Credit Suisse. From Alphaville:

Jonathan Wilmot, chief global strategist at Credit Suisse, reckons that Europe is set to lead a rebound in global growth this year. He and his team are saying BUY Spanish and Italian bonds, and probably equities as well.

While a note dispatched to CS clients this week contains a few escape chutes, the core bullish argument is broadly as follows:

  1. The revival in risk since last autumn is so far very much in line with the recoveries from the “Deep Panics” of 1982, 2002 and 2008/9 – and those panics were followed by rallies of 50 per cent over more in global equities within 18 months.
  2. Despite what you read on sites like this, the eurozone is not going to fall apart; instead some sort of pro-growth compromise will be cobbled together. There’s already consensus on the fact that austerity alone cannot work.
  3. The confidence shock at the end of last year hit Europe the hardest. But while production slumped, aggregate demand didn’t. Hence any uptick in demand now will set up the need for significantly higher European production.

We all know that being a good investor requires that you do just what Mr Wilmot is suggesting: buy the panic. That is hardly news. But, one has to ask, are all panics the same? And is the notion that you should buy equities ipso facto during a period of weakness the right one for the new era in which we live? Is this an era in which the old simplistic assessments of economics still leads to the conclusion that the reversion to a bullish trend can be relied upon in any respectable time frame?

For me the answer is a very obvious “no”.

There are two reasons why I say this, one macro and the other technical. The macro reason is a simple. The advice of Wilmot and Co is not based upon economics at all. It is based upon what is a thin or non existent assessment of political risk. As I wrote last week, there is every chance that Greece will find some new coalition of pro-austerity political parties any minute and that it will remain happily burning in the Eurozone until a new set of policies can be found to reverse its economic collapse whilst applying the Teutonic discipline demanded of it by the European core.

But that potential resolution has nothing whatsoever to with economics or markets. It has everything to with politics and unless the person advising you to “buy the dip” dedicates ninety percent of his reasoning to why the Greek polity is about to have its rage quenched, that advisor is, quite simply, making an ignorant punt.


And that brings me to my major objection to the “buy the dip” framework in these circumstances. Professional investors and especially hedge funds spend a great deal of time seeking out “asymmetric” trades. These are deeply unfashionable trades that are very cheap to lay but contain very large potential upside. Often they involve buying deeply “out of the money” instruments that, in the event of a sudden turnaround in the trend, will trigger an avalanche of interest from the consensus, dramatically boosting the price.

Those suggesting you “buy the dip” on Greece are recommending you do precisely the opposite, making an asymmetric bet with limited upside and large downside potential. Consider, if Greece and Europe do manage some kind of happy rapprochement, then yes, you’ll get some upside. Perhaps 5 or 10% before the reality that global growth will still be subdued sets in. But if Greece exits the euro, you’ve got an almost limitless and unfathomable downside to look forward to as Lehman Brothers II freezes global credit, trashes global equities and potentially ends the era of free global capital markets as governments worldwide nationalise and guarantee every bank in site.

Unless you are going to “buy the dip” using some kind of asymmetric instrument – and good luck with that given the consensus is still firmly on the side of ongoing growth – then you should stay right away from betting on happy outcomes in Greek politics.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.