Author: Michael Arold
Covestor model: Technical Swing
It feels like the Greek crisis is reaching its last inning this week and based on comments from German politicians, probability of a default is rising. What would that mean for stocks?
There are often two mechanisms at play in a situation like this. First of all, equity markets are an anticipatory mechanism – they attempt to have the magic ability to “see” developments that will take place months ahead. The old saying on Wall Street “buy the rumor, sell the fact” summarizes this behavior. Equities declined in recent months, perhaps in anticipation of a default, which could be priced in at this time.
A second feature of the markets is that they often tend to do what nobody expected and thus harm the maximum number of investors. I’m currently reading The Art of Contrary Thinking from Humphrey B. Neil, an investment classic written in 1954. The author describes several historic examples when stocks actually started to rally on abysmal news, such as the beginning of World War I and Great Britain’s entry into WW2. I quote:
Britain, of course, was in the war and we [the US] were not. When everything looked the blackest – practically hopeless for Great Britain, as she was to be alone from then on in combatting Hitler – British [stock] prices started slowly to climb upward [..] until January, 1947!
I believe that the markets could react similarly on a potential Greece default. Media headlines would be extremely negative, probably talking about the end of the Euro and speculating about who would be next to exit the union. Futures would initially slump and stocks sell off in the morning. But based on the two market characteristics outlined above, there is a chance that buyers could show up later and push prices higher.
Politicians were probably pulling a lot of strings in the background for the last weeks and I wouldn’t be surprised to see China, the U.S. or another party come up with a massive coordinated intervention program. I doubt anybody would be unprepared.
Note that I’m not trying to predict this scenario and front-run the market by going aggressively long. As a trader, I’m constantly developing “what-if ” scenarios and prefer to let the market tell me which direction to go. Trading is a little bit like surfing – you scout the ocean for the waves, then get on the board when the wave arrives. You are not able to make the waves and you will go down if you jump on the board too early.
Worst case scenario if I’m wrong and stocks don’t rally is that I will have closed my shorts and be 100% in cash, which won’t be that bad either.
