Lessons About Market Crises from Greece's Quiet Recovery
While Greek debt woes generated plenty of catastrophic headlines, the country's equally remarkable turnaround has taken place out of the spotlight. Greek sovereign bonds have rallied sharply since the summer, and countries ranging from Norway to China have signaled their support.
The lessons for investors, of course, extend well beyond just the Greek economy. Nowadays, markets and media cycles lurch from one potential crisis to another at a velocity seldom seen before. But the next crisis du jour about to slam the financial markets – from the certain implosion of commercial real estate, a run on the dollar or impending sovereign debt crisis – has a way of correcting itself that's easy to overlook at the height of the hyperventilation.
Greece, for example, was seen as proxy for many larger Southern European economies, and prominent economists made blaring pronouncements declaring that a painful wave of defaults and deflation were inevitable. Armies of analysts took to the airwaves to declare that the euro was doomed as images of deadly riots on Athens streets were broadcast around the world.
It was easy to overlook that the highly unionized Greek public sector has a long history of rowdy demonstrations that frequently spin out of control. After all, most pundits were too busy racing to edge out rivals in anticipating where events might lead.
The striking steadying of Greece's financial position over the last several months has taken place with far less fanfare. Greek bonds have rallied a hefty 10% since the summer as yields tumbled 13%, far ahead of the rest of the eurozone.
Rating downgrades for sovereign debt in the region are sure to hammer markets. But Moody's (MCO) recent constructive comments on Greece following the country's largely successful belt-tightening don't seem to be having nearly the same impact on the upside. Similarly, widening credit default swap spreads and offhand comments by politicians in marginal European countries like Hungary can send markets reeling. But a recent tightening of spreads amid renewed investor confidence gets a lot less attention.
The Rise of Hedge Funds
Part of the disconnect, of course, has to do with longstanding human biases. While fear and greed are frequently cited as two ends of the pendulum, the former may be a far more powerful emotion.
But the shifting nature of the financial markets and the perverse incentives of doomsayers at times also play an increasingly important role.
The rise of hedge funds over the last decade, for example, has been staggering. The industry will have an estimated $2 trillion under management by year-end. When it came to the stock market, many of Wall Street's old guard were considered too cheery. But hedge funds by contrast often find betting against assets far more lucrative than attempting to shuttle investors into vehicles like mutual funds.
The rise of high-frequency trading and vehicles like electronic trading funds mean momentum tends to be self-reinforcing to a degree never seen before. Yet, while computerized trading drives prices to extremes and tries to take advantage of hair-splitting discrepancies, those swings are nevertheless interpreted as the verdict of judicious investors -- much as they might have been 50 years ago.
When panic strikes, investors are bombarded with catastrophic interpretations of events. But in reality, the market often is telling investors far less than the pundits and those who profit from mayhem would lead investors to believe.