U.S. Investors Brace for a Third Bailout in Greece

BOSTON (TheStreet) -- Bill Stone, chief investment strategist at PNC Asset Management, isn't worried about more Greek bailouts to come as a second $172 billion rescue was finally completed after months of haggling. He says investors shouldn't be concerned either about the uncertainty that could grip equity markets.

The last-minute deal will see Greek debt holders swap their current bonds for new Greek bonds with maturities between 11 and 30 years. In exchange for taking a steep hit to the face value of the bond along with lower coupons, investors will also get European Financial Stability Facility notes. In total, investors would be agreeing to a 53.5% haircut and Greece's debt would be reduced by about $145 billion. It would also put off any disorderly default by Greece.

But by his count, Stone says Greece has now defaulted twice, even if the credit default swaps haven't been triggered. "If I have to take a 53% haircut on what I own, by my definition that's a default in the real world," Stone says. "When you think about it, you have to imagine that investors will hold it against them going forward."

Stone warned investors in January not to get too caught up in the crisis. In his 2012 outlook, Stone noted that Greece has spent 50.6% of the years from independence in 1800 through 2008 in default or restructuring. The U.S. never was in default during that time. He also notes that sovereigns tend to re-lever quickly following a sovereign default episode. That may explain why Greece, having been in default or restructuring for more than half of the years since its independence, finds itself in trouble yet again.

"The probability remains high that this isn't the end of it," Stone adds. "With debt-to-GDP ratios, you do have to be worried that the IMF definition of sustainable is not the market's definition of sustainable. But I do think eventually that investors will move on."

That seems hard to believe. The Greek debt headlines have been inescapable for investors to the point of exhaustion. Unfortunately, it seems the second bailout is only the beginning. CNBC on-air anchor Carl Quintanilla joked in a tweet that Greece's second bailout is "like a Hollywood sequel: bigger budget, confusing plot, leaves door open to trilogy."

"This is a George Lucas production," quips Paul Nolte, managing director with Chicago-based Dearborn Partners, referencing the filmmaker who brought six Star Wars and four Indiana Jones epics to the silver screen. "The debt hasn't gone away. It's still there. So perhaps a better analogy is that it's like shuffling cards and the joker keeps showing up."

These jokes may not be far off the mark. Both Reuters and The Financial Times separately reported Tuesday on a confidential analysis conducted by the International Monetary Fund, the European Central Bank and the European Commission that shows Greece will probably need additional relief in order to reach that debt-to-GDP ratio of 120% by 2020. Without structural reforms and any meaningful changes, that number could jump to 160% by 2020.

Put another way, this debt crisis for Greece -- the one that investors have grown tired of after more than two years -- could last at least another eight years. Suddenly, the so-called "lost decade" for U.S. stocks over the past 10 years doesn't seem like that big of a problem when investors are staring at the potential for another decade or more of wild, head-spinning volatility.

"It's a never-ending story. That's what investors are dealing with," says Nolte. "There will be another meeting or something will be coming up. There will be another bailout package. There will be another vote. There's always something to be hanging your hat on when it comes to Greek and European issues."

That reality struck investors on Tuesday. The Dow Jones Industrial Average briefly regained the 13,000 level Tuesday for the first time since May 2008, months before the collapse of Lehman Brothers. The follow-through was lacking, however. "You're not getting that violent reaction we usually see," Nolte says. "This deal would be worth 300 points to the upside. We were lucky if we got 20 points."

So how should investors prepare their portfolios against the threat of yet another drawn-out drama that results in another last-minute Greek bailout? For now, both Stone and Nolte note that it's tough to bet against any scenario where central banks are working in coordination with each other.

The obvious example of coordinated central bank action is the long-term refinancing operation, or LTRO, which is essentially the ECB's own version of quantitative easing by flooding banks with unlimited money for three years in exchange for collateral. The first LTRO in December sparked a big rally in stocks, and investors are expecting the same when a second and potentially much larger LTRO is rolled out Feb. 29.

"As long as you have central banks willing to keep the spigots open, it ends up in the financial markets," Nolte says. "But that's not in our pockets, which is where it ultimately needs to be. That's why investors aren't getting too excited about this yet."

The effective use of QE in Europe, as well as other measures by central banks around the globe from the U.S. to China, has resulted in a big rotation in equities. Emerging markets, punished mightily in 2011, have rebounded sharply. Small- and mid-cap stocks have outperformed their larger, supposedly safer counterparts that were safe havens during choppy waters last year.

However, even the more defensive areas have remained expensive after surging through much of last year. Nolte says that leaves few other places for worried investors to move unless they want to rotate into short-term bonds or cash.

"It really sucks," Nolte says. "If you look at the QE-influenced markets, it's been hard to buy dips because there haven't been any except some intraday. The markets are truly manic-depressive. It's more of a trading market, which I don't do very well in."

Others have turned more positive on the market. Andrew Garthwaite, managing director for global equity strategy Credit Suisse, on Tuesday said that for the first time in almost two years, he was less negative on Contental Europe, even if several problems remain.

"We think that the ECB is increasingly dovish (and we would not rule out another three-year LTRO after the one on February 29), which should help weaken the euro," Garthwaite writes. "And we now only expect a 1% decline in European credit (down from our previous estimate of a 5% decline)."

Although that is not enough for Credit Suisse to raise weightings to "overweight," Garthwaite says he would continue to be a buyer of the German DAX, specifically mentioning companies like BMW, Bayer, SAP ( SAP) and Siemens ( SI), domestic German names like Hugo Boss and ProSiebenSat and, interestingly, Italian risk. He says he would avoid French risk and remains relatively cautious on Spain.

Deutsche Bank commodities analyst Michael Hsueh, meanwhile, notes that commodities have performed strongly over recent days leading up to the second Greek bailout. Hsueh argues that with the deal out of the way, contagion risk in the euro area will subside and attention will move back towards commodity fundamentals. That could mean further gains for oil prices "with U.S. consumers likely to be more resilient to higher gasoline prices today than in 2008."

Others on the sell-side are cautious on equities, however, without even taking Europe into account. For example, Citigroup U.S. equity strategist Tobias Levkovich on Tuesday said in a research note that he sees a fairly low probability of market appreciation due to the disappointing momentum of earnings revisions.

"Earnings estimate revisions are not supportive of the stock market surge," Levkovich wrote. "Typically, there is a tighter relationship between earnings and the S&P 500 and the divergence is worrying in the short term."

Levkovich did not alter Citi's year-end target of 1,425, and he says that the near-term concerns with ongoing bullishness for 2012 and buying on weakness makes sense rather than chasing the tape.

For those investors still worried about Europe, though, it seems the question is whether the second Greek bailout solves the crisis or whether it's just another successful delay in extending the crisis indefinitely. Given how often Greece has been in default or restructuring, it seems to be that the latter is a smarter bet.

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

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