​The Passive-Aggressive Greek & Junk Bond Tragedy

Ivan Illán |

Remember when you had to read Oedipus Rex and The Odyssey? Most secondary schools introduce to young minds the high drama of Ancient Greek mythology. The love, lust, and vicious revenge and greed make for great story telling. The finance world is equally drama-filled, but less clear about what is really happening. Many investors would be hard-pressed to give details on what exactly the economic crisis in Greece during 2012 was all about. They’d be more at a loss to explain why today, the debt markets are priced as if the Greek economic crisis never happened and moreover, never will again. This is a dangerous fiction.

Here’s a little synopsis on Greece’s economic crisis, which reached a fever pitch by 2012. Greeks don’t like paying taxes, and most transactions are cash-based. This led the nation into a nasty reality check, with a series of proposed austerity measures (like, you can’t retire at age 50!). Protests ensued on Athenian streets, and an eventual bailout from the ECB and IMF (European Central Bank – funded mostly from Germans who’d prefer to do something else with their money) put a band-aid on the situation.

Years have passed, but little has fundamentally changed. Greeks still don’t like to pay taxes, and their government has a darned near impossible task of collecting taxes from its people. And yet, with all this unchanged behavior, the sovereign debt of Greece is priced with much less yield than CCC corporate junk bond debt (chart above). U.S. corporate junk bonds pay about 820 basis points (bps) more than investment grade debt across the yield curve spectrum. Greek debt offers much less spread with only 530bps over German debt. Both are at their narrowest spreads in years.

Debt investors are wrong. U.S. junk bonds and Greek sovereign paper are priced far too positively for their underlying risk. Current prices completely ignore the real unchanged probability of defaults on interest and/or principal payments. Looking back to 2012 for Greek debt which had 3000 bps spreads and junk bonds had 4000 bps spreads, it’s clear that we will not hit those peaks anytime soon. Our current geopolitical environment provides a market put on these debt markets preventing the display of their true aggressive, loss of capital nature. Instead, we have to accept that these more risky debt markets are now in an annoying, passive-aggressive relationship with our capital markets. As such, it’s only a matter of time before this relationship sours, and returns to an expected risk/return profile.

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