The Eurozone and Greece: A Client Update 6/28/2012

by Sergio Mariaca on Jun 28, 2012 9:50:00 AM |Share:

economy volatility debt political bailout

Events in the Eurozone, particularly Greece’s future participation in the currency union, have been the overwhelming focus of investors worldwide in recent months.

Naturally, many clients are asking about Dimensional’s exposure to the countries at the center of the crisis, the protections we have in place, and how we would respond if events deteriorated from here.

This brief paper provides answers to these questions and places them within the context of our calm, disciplined, and risk-aware processes.

In doing this, we reaffirm our belief that basing investment decisions on forecasts is counter-productive—something even more true in such a rapidly developing and multi-stranded story. As always, news is quickly reflected in prices and there is little to be gained from speculating about likely outcomes.


The current crisis is a complex, multi-faceted, and constantly evolving story. But at its heart is concern over sovereign debt burdens in the Eurozone—an economic and monetary union of seventeen countries that adopted the euro as its common currency in 1999.

The Eurozone consists of Germany, Austria, France, Belgium, Luxembourg, Spain, Portugal, Italy, Greece, Cyprus, Ireland, Malta, the Netherlands, Slovakia, Slovenia, Finland, and Estonia. Another ten members of the wider European Union are not part of the single currency zone. So far, the Eurozone crisis has focused on a handful of countries—particularly Greece, Ireland, Italy, Spain, and Portugal.

At its heart, the volatility in markets globally reflects worries over the capacity of European policymakers, despite a succession of bailouts, to deal effectively with the debt legacy while holding the currency union together.

Newest pic graph



The possibility of Greece leaving the Eurozone, triggering a string of sovereign defaults, has been the focus of the markets’ recent attention. While a rerun national election in Greece on June 17 provided hope of a positive outcome, uncertainty remains at high levels.

Outside the sovereign debt issue, there is also concern about the impact of the crisis on the Eurozone banking system. Refinancing by the European Central Bank in early 2012 provided short-term relief for the banks, but market pricing points to worries over the longer-term solvency of many institutions.

However, this crisis is as much a political as an economic affair. Austerity programs imposed in several countries as conditions for repeated bailouts from the European Union and the IMF have sparked social and political unrest. Elected governments are torn between their responsibilities to creditors and the anger of some of their taxpayers who do not wish to pay for what they see as the profligacy of bankers and politicians.

Meanwhile, Europe’s inability to deal conclusively with its problems is creating international tension as governments elsewhere voice concern about the impact of the crisis on global economic growth. Germany, the most powerful economy in the Eurozone, is accused by its critics of pushing austerity at the expense of the growth needed for the peripheral countries to pay back their debt.


In relative terms, Greece is a very small economy. According to an IMF list of the world’s economies ranked by size (GDP in purchasing power parity terms), it is 42nd, below Chile and above the Czech Republic.

However, Greece’s public debt is large at around 160% of GDP. Athens has received a total of US$300 billion in bailouts from the IMF and the EU, the latest US$160 billion payment on the condition of imposing austerity measures to reduce debt to 120.5% of GDP by 2020.

In March, Greece avoided an uncontrolled default on its obligations by agreeing to a bond swap with private creditors. Still, after five years of recession, there does not appear to be much public support for further cutbacks. Amid this backlash, national elections on May 6 failed to yield a definitive outcome.

A run-off poll on June 17 provided a clearer outcome, with the two largest pro-bailout parties (the centre-right New Democracy and its traditional opposition the Socialist Pasok party) winning enough seats to form a parliamentary majority. This provided some immediate reassurance to markets. Even so, the incoming government still has to convince official lenders of its capacity to push through required reforms before securing further bailout funding.

For their part, European governments have indicated a willingness to adjust the terms of the bailout as long as a new government "swiftly" emerges. And central bank officials from leading developed economies are quoted by Reuters as saying they stand ready to flood the financial system with cash on any credit squeeze.

So even after the latest elections, there are still a lot of unknowns around the future of Greece in the euro and the capacity of European policymakers to hold the single currency together. Some market participants have speculated on Greece holding on, others predict a complete break-up of the euro, while still others believe a smaller union will emerge, built around Germany, France, Italy and Spain.

It should be noted that this information is merely provided as background and context. The final outcome—and perhaps more important, the process that it will take to get to that stage—is still not certain. However, all these possibilities should be incorporated in market prices.

It is what happens next that counts—and no one knows the answer to that question. So our approach remains the same.


Dimensional’s Investment Committee has been monitoring the situation in Greece, together with our Portfolio Management and Trading teams.

In particular, the teams have planned a course of action and assessed potential impacts should a Greece exit from the Eurozone occur. In this event, our Investment Committee would review Greece’s status in our portfolios and consider changing its trading status.

Even so, the fluidity of the situation means the committee could change Greece’s trading status at any time. The review procedure is an independent process. We review countries on an ongoing basis and not on a set timetable. While information gathered in the market and official announcements are considered, the committee may rule on a country’s eligibility based on our internal research.

In a previous meeting, the committee suspended purchases in Greece for all equity portfolios. This was due to uncertainty over whether Greece will retain its developed market status in our strategies, as well as potential operational risks associated with equity and currency trade settlement in the event of a Eurozone exit.

Greece is a small country by market capitalization and therefore generally makes up a relatively small portion of portfolio holdings within our equity strategies where it was eligible for investment. For example, as of May 29 for those strategies holding Greek equities, Greece’s weighting ranged from less than 2% of portfolio assets in a European-only strategy to less than 25 basis points in a global equity strategy. In fixed income, Greece is not and has not been an eligible country for our strategies, so a review is not required.

Meanwhile, we continue to consult our relevant counterparties, including custodians, brokers, and middle office providers, regarding trading conditions in Greece and their contingency plans should a change in currency occur.

Our portfolio management and trading systems are designed to be adaptable and have been modified in the past to accommodate new investment strategies, enhancements in existing strategies, and changes in markets. We have been conducting a review of those systems should any changes to currencies be announced.


While parallels have been drawn between this phase of the Eurozone crisis and the Lehman Brothers collapse of October 2008, measures of stress in equity and money markets are far below the levels seen during that period.

One equity measure is the Chicago Board Options Exchange’s "Volatility Index." Sometimes known as the "fear index," this is a barometer of the market’s estimate of future volatility of the US equity market over the coming thirty days.

The chart below shows the index has been hovering around the low to mid-20s in recent weeks, significantly lower than its 2008 peak levels near 80.

Greece pic 2

In the credit markets, a closely watched barometer of stress is the three-month London Interbank Offered Rate, or LIBOR. This refers to the interest rate banks charge each other in the wholesale money markets in London for ninety-day loans.

Greece pic 3

Leading into the Greek election, the three-month US dollar LIBOR was around 0.47% and had been steady at those levels for twenty consecutive sessions. In comparison, LIBOR was at more than 4.0% in October 2008.

Another measure of sentiment is the credit default swap market. Credit default swaps (CDSs) are a form of derivative that allows investors to take out insurance against a loan default. There are CDSs for corporate and sovereign borrowers.

Greek CDSs have been prevented from trading since early March after breaching a technical provision. However, even after the removal of that obstacle in the past week, most dealers have refused to renew quoting them due to the uncertainty around the vote.

The pricing of other Eurozone CDSs moderated earlier this year as refinancing agreements were reached, but they have since returned to near the elevated levels of December. The most marked deterioration has been for Spain, whose swaps have blown out by more than 200 basis points since the start of the year to just over 600 basis points.

In this case, risk measures are much higher than in 2008 when most of the focus was on the banking system rather than on sovereign debt.

But this is also another way of saying that much of the bad news is already in the price.


Nearly three years since it began, the European sovereign debt crisis continues to create great uncertainty in global financial markets.

This is understandably an anxious time for investors. The crisis has raised questions about not only the sustainability of sovereign debt burdens in Europe, but about the future of the common currency experiment.

At a wider level, investors globally are expressing concern about the impact of the crisis on economic growth rates and the financial system itself.

However, as we have seen, the extent of uncertainty—as expressed in market prices—is nowhere near the levels reached during the Lehman crisis of late 2008.

It is also worth noting that policymakers in the major economies, both inside and outside Europe, have made contingency plans to ensure liquidity is made available in the event of any future strains in credit markets.

On Dimensional’s part, our senior investment team is closely watching developments and stands ready to review the status of Greece and other Eurozone participant countries should the circumstances merit it.

We have zero exposure to Greek government debt, as Greece is not eligible for our fixed income strategies. Our exposure to Greek equities is minimal, and we have suspended further purchases in that country for the time being.

We understand the anxiety of clients at this time. Like you, we do not know what the future holds. But we do know that markets incorporate all known information and that the widespread anxieties are already reflected in prices.

Finally, you can be confident that our disciplined investment processes, the flexibility of our approach, and the quality of our investment team position us extremely well to continue to manage our portfolios in the best interests of clients.

We are always happy to answer your questions and stand ready to provide any further clarification you need.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.  All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services.


2011 Review: Economy & Markets 1/11/2012

by Sergio Mariaca on Jan 11, 2012 12:29:00 PM |Share:

Economic recap economy us economy investment management wealth management

The past year reminded investors that they should hope for the best, prepare for the worst, and be thankful when reality does not match their fears. Investors entered 2011 with hopes that the world economy would continue recovering from a long and painful deleveraging process. Equity markets had posted two straight years of positive performance, central banks remained committed to pro-growth monetary policy, and major developed nations were focused on reducing debt.

By mid-year, however, optimism faded as troubling events around the world dominated headlines. The devastating earthquake and tsunami in Japan, political unrest in the Middle East, rising oil prices, a US credit downgrade, the threat of another global recession, and an escalating debt crisis in Europe weighed heavily on markets. As stock market volatility returned to global financial crisis levels, investors faced a major test to their discipline and staying power.

Although US stocks experienced some of the highest volatility in years, the broad US market delivered flat performance in 2011. Developed markets logged negative returns, and emerging markets had mixed performance, with most countries also underperforming the US. The bright spots were in the fixed income arena, where a flight to quality triggered by the euro debt crisis and US credit downgrade boosted returns on US government securities, inflation-protected securities, and municipal bonds.

describe the image

The above headliner graph features some of the year’s most highly publicized events in the context of the Russell 3000 Index, a broad indicator of US stock market performance. These events are not offered as an explanation of market performance, but as an illustration that a volatile news environment can challenge even the most disciplined long-term investors.

The World Stock Market Performance chart below offers a snapshot of global stock market performance, as measured by the MSCI All Country World Index. Actual headlines from publications around the world are featured. Again, these headlines are just a sample of events during the year.

 describe the image

Throughout the year, investors could find a host of reasons to avoid stocks and wait for more positive news before returning to the market. As these select headlines suggest, determining the right time to invest is a difficult task since the market anticipates news and quickly factors in new information.

The Year in Review

In 2011, global diversification proved as important as ever. Although diversification may not have prevented losses, investors with broadly diversified portfolios were better equipped to endure the uncertainty. Major themes during the year included:

European Debt Problems

The sovereign debt crisis intensified as European authorities struggled to avert a Greek debt default and alleviate fiscal pressures in Italy and France. But these restructuring attempts fell short of market expectations, which spooked investors and raised concerns of additional sovereign debt downgrades and a possible breakup of the Eurozone. The crisis also hurt European banks holding large positions in sovereign debt. To avoid losses, leading institutions reduced lending and dumped assets, which depressed asset values. Higher borrowing costs in the most indebted countries, combined with reduced government spending and revenues, raised more concerns that the Eurozone was entering a recession in late 2011.

Economic Uncertainty

Since the global financial crisis in 2008, central banks and governments have taken bold measures to fuel business activity and stabilize financial markets—and investors have eagerly awaited signs that economic recovery has taken hold. The economic signals continued to be mixed in 2011. Favorable US news included strong corporate profits and dividends, substantial levels of cash on corporate balance sheets, low interest rates and inflation, a booming domestic energy sector, continuing strength in auto sales, record-high share prices for some multinationals, and improved fourth-quarter numbers in manufacturing, exports, consumer confidence, and employment. Pessimists could point to the longstanding jobless trend, slumping home prices, tepid growth in retail sales, worrisome levels of government debt, and political gridlock at both the national and state levels.

Although emerging economies showed resilience, investors were concerned that another recession in Europe would impact its trading partners in emerging economies—and particularly in China, where high inflation and a manufacturing slowdown threatened to send its previously fast-growing economy into recession.

Rising Volatility

Investors in US equities had to endure a heavy dose of uncertainty for their moderate gains. The S&P 500 Index reflected this volatility by closing up or down over 2% on thirty-five days in 2011, compared to twenty-two days in 2010. By contrast, before the global financial crisis, the index did not have a single day with a 2% or more movement in 2005, and only two days in 2006.

Market observers also documented higher correlations among individual stocks and between asset classes. In 2011, there were sixty-nine days in which 90% of the S&P 500 stocks moved in the same direction, which is more than the combined total for 2008 and 2009. Higher correlations are common during periods of uncertainty, as macroeconomic forces overshadow the impact of a company’s business fundamentals on its stock price.

Falling Commodity Prices

In early 2011, commodities soared with expectations of improving economic growth around the world. Copper, cotton, and corn hit all-time highs in the first half of the year. Crude oil experienced double-digit returns in response to anticipated higher demand and threats of supply disruptions tied to political unrest in the Middle East. The Dow Jones-UBS Commodity Index peaked in April, then fell 20% as the global economic outlook faded. The index returned -13% for the year—its first negative return since 2008. The most notable exception was gold, which set more records in 2011 and peaked at $1,888.70 per ounce in August before declining in the fourth quarter to return about 10% for the year.

Investor Risk Aversion

The fragile world economy made markets particularly vulnerable to shifting investor sentiment. During the year, investors reacted to uncertainty by moving to asset classes they deemed more stable, including large cap stocks and government bonds. Despite the Standard & Poor’s downgrade of the US credit rating in early August, investors fled to US government securities as concerns mounted over the sovereign debt crisis in Europe and political stalemate over the US debt ceiling.

2011 Investment Overview

Most global equity investors experienced negative returns in 2011. After a strong first-quarter start, developed equity markets grew more volatile in response to discouraging news on the economy and sovereign debt crisis. Despite a brief rebound in July and during the fourth quarter, most equity markets logged negative performance for the year.

The US stock market was one of the few developed markets to experience positive returns. The S&P 500 logged a 2.11% gain (dividends reinvested), and the Russell 3000 returned 1.03% for the year. Despite strong returns in the fourth quarter, developed and emerging markets logged negative returns, with forty of the forty-five countries that MSCI tracks posting losses. The MSCI World ex USA Index returned ­12.2% and the MSCI Emerging Markets Index returned ­18.4% for the year. Ireland and New Zealand were the only developed markets besides the US to end the year in positive territory, and Greece was by far the worst performer. Indonesia and Malaysia were the only emerging markets that ended the year with positive returns, and Egypt was the worst performer.

The US dollar fluctuated but finished about 3% above where it started against most developed-market currencies. It sharply appreciated against the main emerging market currencies, especially against the Indian rupee and the Brazilian real. This relative strength negatively impacted dollar-denominated returns of emerging market equities. The euro remained stable during the year even as analysts began predicting the dissolution of the currency zone, and the Japanese yen and the Australian dollar both gained against the US dollar.

Along the size dimension, large caps outperformed small caps in the US, non-US developed, and emerging markets. Value stocks underperformed growth stocks in the US, but mostly outperformed growth among emerging markets and had mixed results in developed markets.

In the fixed income arena, US intermediate-term government securities and TIPS performed exceptionally well, returning over 9.4% and 14.5%, respectively. Real estate securities in the US had strong positive returns and excellent performance relative to other US asset classes; in other developed markets, REITs had sharply negative returns but still managed to have good performance relative to other asset classes.


Russell data copyright © Russell Investment Group 1995-2012, all rights reserved. Dow Jones data provided by Dow Jones Indexes. MSCI data copyright MSCI 2012, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2012 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Citigroup bond indices copyright 2012 by Citigroup. Barclays Capital data provided by Barclays Bank PLC. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. 
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.





Third Quarter - Economic Update 11/30/2011

by Sergio Mariaca on Oct 1, 2011 1:00:00 PM |Share:

Economic recap economy us economy


Stock markets had a turbulent quarter amid investors’ growing despair about political efforts to deal with the monumental challenges facing the world economy. The Dow Jones Industrial Average ended the quarter down 12%, its worst percentage decline since the first quarter of 2009. The Standard and Poor’s 500 Index suffered an even bigger 14% decline. The damage was much worse in Europe, where the French and German stock indexes both lost more than 25% of their value. Asian stocks also took a pounding, suffering losses into the double digits as well. Hong Kong’s index, for example, lost about 21%. (Source: WSJ, October 3, 2011 – Spooked Investors)

This was caused primarily by investor anxiety—Europe is in a debt crisis, the U.S. is flirting with a double-dip recession, and fast-growing economies around the world, such as China, are slowing down. Many investments, from U.S. stocks to crude oil to even some emerging market currencies, had the worst quarter since the collapse of Lehman Brothers in 2008. Like 2008, many investors are worried about the health of banks (this time primarily in Europe) and have lost confidence in the system. Financial stocks were among the hardest hit during the quarter, with many banks falling 25% or more. Many Wall Street strategists have reduced their forecast for growth and company earnings for the rest of the year. (Source: WSJ, October 1, 2011 – Stocks Log Worst Quarter)

The difficulties lasted throughout the quarter—when the market might have wanted to go higher, something always seemed to come along and knock it down. This onslaught of bad news, along with occasional flashes of optimism, led to one of the most volatile periods ever for stocks. The Dow moved by more than 200 points 18 times during the quarter. In August, it swung more than 400 points in 4 consecutive days! Many markets were tossed up and down on a daily—even hourly—basis by the latest news from Washington or the European capitals. In August and September, the Dow rose or fell by more than 1% on 29 days and there were 15 days with final moves of more than 2%. (Source: WSJ, October 1, 2011 – Stocks Log Worst Quarter)

Unfortunately, there are many signs globally that do not appear very favorable. Leading indicators for the world economy—such as China’s stock market, copper prices and crude oil—have tumbled. Here at home, economic data in July showed the U.S. recovery was slowing considerably, and policymakers in Washington took the country to the brink of default in early August due to the debt ceiling problem. Standard and Poor’s downgraded the U.S. credit rating, sparking a rush out of U.S. stocks, while Europe’s debt troubles deepened. Many investors felt that the fate of the markets was in the hands of the politicians, which made risk management very difficult.

Although there wasn’t anything that specifically stated the U.S. economy was going into a recession, there weren’t any clear signs that the economy was returning to robust growth either. Many economists believe that we remain stuck in neutral. Job growth is anemic, at best, the housing market remains stuck, and the stock market still needs to recover. On
the other hand, consumer spending continued to remain at the same pace, and corporations continued their record profits.

There are many indicators that are causing many investors to be nervous:

  • Uncertainty about the economy’s slow spending.
  • Corporations have the cash, but are afraid to spend it.
  • Regulation is stifling the economy.
  • Europe is responsible for 27% of our exports. (Source: BTN, October 3, 2011)
  • Europe’s problems could cause significant negative consequences to the U.S.

For years, many investors have been trained that they need to invest in equities for growth. However, the magnitude of the market swings over the last 3 years is likely to have a lasting impact on investor psychology, especially those who may have sold out at the wrong time and missed some or all of the rebound. A recent post-recession survey found that protecting assets is now 5 times more important to Americans aged 55 and older than achieving higher returns. These investors realize that their portfolios may miss sizable growth opportunities from big market gains because they are not invested, but feel that they cannot afford to lose any more of their retirement savings.

Unfortunately, many people only had one thing in mind—safety! Many investors sold and raced for the exits and it is still unknown whether or not this was the wisest thing to do.


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