Why stocks should not worry about a Grexit

By Mark Hulbert

CHAPEL HILL. N.C. (MarketWatch) — Investors are needlessly worrying about the prospect of Greece defaulting on its debt and withdrawing from the eurozone.

Consider: If a Greek exit from the euro EURUSD, +0.7134%  — a “Grexit,” as this possibility is being called — were really a cause for worry, then why aren’t the recent British elections causing a huge panic? After all, the Tory Party’s resounding victory, along with its anti-European Union stance, is leading some to speculate that the U.K. could leave the European Union as soon as next year — a so-called Brexit.

And the U.K. economy is far larger than Greece’s: In fact, the U.K. economy is the second largest in the European Union, representing 16% of the total GDP of the all member countries. Greece’s GDP, in contrast, represents just 1.3%.

Far from plunging, however, European stocks appear to be shrugging off the U.K. election results.

Either investors are in denial about the investment significance of a Brexit, or they’re exaggerating the significance of a Grexit.

My analysis of stock market history inclines me to the latter explanation. Sovereign debt crises like the one Greece has been suffering from in recent years are not particularly rare, and more often than not following past such crises, the stock market rose.

And not by a little bit, either. Consider the stock market’s performance following the four such crises prior to Greece’s. These four were:

• The 1994 Mexican peso devaluation and associated crisis
• The Thai government debt crisis in 1997, which led to the phrase “Asian contagion”
• The 1998 Russian ruble devaluation in August 1998, which — among other things — led to the bankruptcy of Long Term Capital Management
• The 2001 Argentinian government debt/currency crisis

The chart at the top of this column shows how the U.S. stock market on average reacted to these four crises. The chart also plots how the stock market has performed since the Greek debt crisis first erupted 5+ years ago — in November 2009. For both data series, 100 represents the stock market’s level when those crises first broke onto the world financial scene.

Notice the broad similarity of the two data series. Far from being out of character, in other words, the stock market’s reaction to the Greek crisis has been remarkably similar to how it reacted on other similar occasions.

Note carefully that I didn’t cherry pick my four crises after the fact in order to come up with a sample that matches the market’s behavior over the past five-plus years. I first created this sample in March 2010, when the European debt crisis was just over three months old. That’s when I reported that stock markets typically take sovereign debt crises “in stride.”

The explanation for this otherwise surprising reaction to terrible news has to do with the massive fiscal and/or monetary stimulus that is the nearly universal government response to such crises. Regardless of the long-term wisdom of such stimulus, few dispute that much of that stimulus finds its way into the stock market.

In arguing that investors are making too big a deal about Greece’s travails, I’m not saying that there aren’t plenty of others things to be concerned about — many of which I have discussed in recent columns.

But if you have been staying out of the stock market solely because of concerns about a Grexit, you might want to reconsider.