Back in July, I re-posted an article that my good friend, Chris, at Capitalist Exploits had written about Greece. I had found the idea of a Greek economic recovery intriguing, but hadn’t really followed up on it. Over the following weeks, a number of people reached out to me and noted that I really should take a more serious look. In particular, they said that I should look at the Greek banks, as they are potentially undervalued and highly leveraged to any recovery. Since the flight from Bishkek, Kyrgyzstan to Miami effectively passes over Greece (with a stop in Istanbul), I figured it would be silly not to stop for a few days. So, I rounded up some investor friends and decided to learn something about Greece. Here’s that story.
Sitting in Greece, the American Great Depression looks like a picnic. Greece has been in a 9 year recession that has seen almost 30% unemployment, and nearly a third of GDP disappear. Property prices are off by roughly half and tens of thousands of businesses have closed as a result of crushing debt-loads. There have now been three rounds of bank re-capitalizations and there may very well be a fourth round. In summary, the economy is a mess and Greece is insolvent. As we all know, a crisis creates opportunity and I went to Greece to learn what I could about it. However, before looking at the opportunity, it’s important to understand how Greece got into this mess.
It all started with the conversion of Drachma into Euros in 2000. This led to a virtuous cycle where Greek interest rates converged with European rates, allowing both the government and the private sector to borrow excessive sums at declining interest rates, creating a huge consumer debt and property bubble and allowing the Greek government to embark on substantial increases in social programs, that increased consumer spending. As this was going on, a shipping boom endowed many wealthy Greeks with generational sorts of profits that were plowed into more leverage and vessels, creating thousands of high-paying jobs in the process. When things were going well, they were going very well, despite multiple growing imbalances in the Greek economy.
When the 2008 crisis hit, these imbalances also hit. Unable to fund its trade, current account and fiscal deficits, Greece should have devalued its currency to become more competitive. Unfortunately, by trading Drachmas for Euros, Greece lost this ability. Greece could have defaulted, as US cities have done when faced with a similar dilemma, but the Troika threatened expulsion from the Euro if Greece did that. Instead, the government submitted to an austerity program instituted by the Troika. The problem is that when Greece cut spending and raised taxes in order to balance the budget, it also starved the overall GDP, which makes the debt to GDP ratio worse. Reduced GDP meant that businesses had less income to cover their interest costs—leading to an accelerating spate of bankruptcies. This then led Greece to miss its Troika mandated budget targets, leading to new rounds of austerity and new waves of corporate bankruptcies. Greece has been in this downward spiral for 9 years now, with annual increases in austerity that have served to further strangle the economy.
Of course, the austerity hasn’t been the only cause of the continued crisis. Political volatility, threats of a left-ward lurch in the government and anti-business actions by 3 successive governments have made these issues worse, while threats to leave the Euro have scared off international investors and domestic depositors. Fortunately, this is mostly in the past. The time to leave the Euro was in early 2015, just as the radical left SYRIZA government came into power. SYRIZA played chicken with the Troika in an effort to force debt reductions, but ultimately blinked and in the process, became dramatically less radical and more centrist. There is no longer a strong party that is politically left of SYRIZA or focused on abandoning the Euro and the center right New Democracy party is leading in the polls. Either party now seems benign for the economy while foreign investors would likely welcome a New Democracy win.
With the politics in Greece finally stabilizing, the economy itself has begun to recover. Greece completed its second IMF review in June of 2017 and following that, multiple economic statistics are printing positive for the first time since 2007. Greece floated its first sovereign bond in 9 years in July at a yield of 4.625%, more bonds are to follow. While chaotic, privatizations are finally beginning. Additionally, despite exchange controls, deposits are returning to the banking system, allowing banks to repay their ELA facilities and ultimately begin to make new loans that support economic growth. The third review is expected to be completed around March of 2018, at which point Greece will have exited from the IMF program, though it will still have to follow many conditions.
While the economy is clearly on an up-swing, there is much that is still unhealthy; the banks have Non-Performing Exposures (NPEs) in the high 40s, the Greek government can never repay its debts and new rounds of austerity are envisioned in 2018 and 2019. Additionally, excessive bureaucracy and high taxes serve to cripple businesses, while most companies are still operating at crushing debt levels which do not allow them to de-lever, much less invest in a recovery. Finally, Greece has suffered a brain drain over the past decade that it may never fully recover from. Still, Greece is witnessing its first green shoots in a decade and as an investor, I’ve taken note of this.
Remember, huge gains can be made when a situation goes from awful to slightly less bad. I believe that after 9 years of economic contraction, Greece is in such a situation today and all indicators seem to show that the bottom in the economy was sometime this spring. While I expect the next few years to show a muddle with 1-2% GDP growth, a recovery from crisis to stability could lead to a lot of upside in certain sectors that have been abandoned by investors. I’ve spent the last week taking dozens of meetings with everyone from senior management at 3 of the 4 systemic banks, to property companies to senior government officials to your average Uber driver and bartender. If ever there was a time to buy into Greece, now is the time—especially as almost nobody in the investment world is talking about it—making my view one of deep contrarianism. The question for me is; how to play it?
To be continued…