How the Greek Rescue Could Play Into U.S. Stock Prices

Greece Finance Minister George Papandreou Greek debt rescue
Greece Finance Minister George Papandreou Greek debt rescue

On Friday morning, Greek Finance Minister George Papandreou announced that Greece has finally decided to ask for a loan package from the European Union (EU) and the International Monetary Fund (IMF). If you read this news from America, you might wonder how it could play into the many forces that can affect the value of your U.S. stocks.

One early answer is that today stocks in Europe rose on the news (and they're up in early-morning trading in New York). Once again, investors are apparently reacting hopefully that a sovereign default of a European Union nation can be avoided. Such a default would be bad news not just in Europe, of course, but throughout the financial world.

A Greek rescue would likely help restore some of the euro's strength against the dollar. And while a weaker dollar could help American stocks in the short run, it will take more rapid earnings growth to boost them in the medium term.

The money markets have reacted to the latest turns in the Greece saga in a way that suggests a decline in fear. Ten-year Greek government bond yields fell from a record 9% on Thursday to 8.1% on Friday, while the euro rose against the dollar after hitting a 2010 low point Friday before the announcement.

Still, all is hardly well with Greece's balance sheet. The EU's number cruncher, Eurostat, raised its estimate of the country' 2009 budget-deficit-to-GDP ratio to 13.6%, 0.7 percentage points higher than the Greek government recently predicted. And Moody's Investors Service cut Greece's sovereign rating to A3 from A2 and may downgrade more due to "significant risk that debt may only stabilize at a higher and more costly level than previously estimated," it said.

Up Now but Down Later?

The Greek rescue will likely temporarily boost the euro relative to the dollar. Bloomberg Businessweek, however, suggests that the positive effect on the euro may wane over the longer run. That long-term loss of value in the euro would be due to Greece's decision to accept IMF aid, suggesting that the EU lacks the financial strength to solve its financial problems on its own. The rescue also emphasizes the EU's generally fragmented nature -- witness the complex process of getting Greece's rescue loan approved.

At least for however long it lasts, a weaker dollar might be good for American exporters because it would help them gain market share by selling their products at a relatively lower price in eurozone countries. But a weaker dollar would also boost commodities prices since many, such as oil, are traded in dollars. A weaker dollar means it takes more of them to buy a barrel of oil.

For investors who own stocks in U.S. exporting companies, the higher profits should translate into higher stock prices. But the next question for the euro is whether the Greek drama is merely the first act of the EU's economic implosion that will feature problems with Spain and Portugal in future acts.

A Stronger Dollar, for Good Reason

Longer-term, I'd guess that the dollar is going to strengthen relative to the euro as investors decide they can't use the euro as a reserve currency. But a stronger dollar wouldn't necessarily be bad for stocks, especially if the main reason for it is rapid profit growth among U.S. companies. (I wrote on April 9 that S&P 500 earnings are forecast to grow 28.3% in 2010 and 20.5% in 2011.)

My conclusion is that U.S. stocks are going higher. In the short term, that boost could come from a weaker dollar as the euro rallies on relief over the Greek rescue. But in the medium term, U.S. stocks will go higher because cash will pour into stocks due to higher-than-expected earnings growth.

Investors will also buy dollars in the medium term as the U.S. economy recovers and confidence in the euro declines, which will cause the dollar to rise. But the positive effect of the rapid earnings growth on U.S. stocks will overwhelm the potentially damping force of a rising dollar.