With Greece remaining the central focus for investors, market analysts are looking to assess the potential outcomes that could be seen if the country is forced to leave the European Monetary Union and abandon the use of the Euro currency. While Greece only accounts for 0.4 percent of the global economy, the effects of this scenario could be drastic, and this can be seen already in the way market volatility reacts to headlines that are suggestive of negative events in the country. While the majority of the market analysts do not expect Greece to exit there is a growing minority that is viewing this as a real possibility.
So, what is the worst case scenario and how can traders prepare for this outcome? In the worst case scenario a Greek exit from the Eurozone would likely lead to sovereign credit defaults, excessive and possible unsustainable withdrawals from private banks and the combination of these factors could lead to a global credit crunch as bank liquidity becomes scarce and lead to recessions in other Euro member nations. By extension, we could also see additional sovereign exits from the Eurozone and the accompanying market uncertainty would be a substantial negative for regional stock markets and the Euro currency in particular.
Wider Contagion Effects
Whether or not Greece actually leaves the Eurozone will likely have an impact on other continents as well. According to estimates released by JP Morgan, a 1 percent reduction in Eurozone GDP could lead to a slowdown in global growth of more than 0.5 percent, with most of the declines seen in export centered economies (such as those in emerging Asia). Commodity producing countries, such as Canada, Australia and Russia would also see a large amount of the impact as oil prices would likely see major declines on reduced energy demand.
Given that the US doesn’t fit into many of these categories (as a net importer of foreign goods and relatively low levels of commodities production), some of the effects there could be limited and equity markets such as the S&P 500 and the Dow Jones will likely outperform most of its global counterparts. So how can investors position for these potential outcomes? Depending on which scenario unfolds, European assets remain in a position to see continued losses, with currencies markets likely to be in the most vulnerable position, given that stock markets are not joined by the common bond of a monetary unit (the Euro). With this in mind, European equities will likely outperform the Euro, while the US Dollar is less exposed and thus less likely to meet sustained selling pressure for the remainder of 2012.