Tellus exits Greece, for now

Last Friday we had two Greek government bonds in the Tellus portfolio. Together they amounted to 6.8% of the portfolio. We began selling the holdings on Monday, and the remainder of the position, constituting 2.4%, was sold on Thursday morning.

The decision to sell was made over the weekend. Late last week Greek government bond yields fell somewhat. But on Friday evening, after the market had closed, the Greek government submitted a 2015 budget to the parliament that did not comply with the demands of the so-called Troika, i.e. the IMF, the European Commission and ECB. While parts of the budget made sense, such as shaving some tax rates, it failed to include further cuts in pensions and other budget posts that are probably necessary to get a sufficient surplus in 2015.

The Troika is currently considering whether Athens fulfils the conditions for the payment of the last instalment of bail-out loans provided by the IMF and the EU. While the Greek government is eager get its hand on that money, domestic politics makes it difficult to comply with the Troika's demands. The meeting in Paris on Wednesday and Thursday ended without a deal. It is unclear when representatives of the Troika will be back in Athens, and it is unclear how much leeway Prime Minister Antonis Samaras and his cabinet have.

The crucial issue is not the last instalment that is supposed to be paid out in 2014 but how Greece is going to be supported in 2015 and beyond. The Greek government wants a credit line from its Eurozone partners, no further involvement from the IMF, and to regain full sovereignty over fiscal matters. The EU Commission and the ECB insist that the IMF continues to play a role and that further credit is contingent on fiscal and structural policies.

The Greek government had hoped that everything would be settled on 8 December when the finance ministers in the EU have a meeting. This is not going to happen. Another meeting of the finance ministers might be scheduled later in December though. That will depend on the Troika's final verdict on the Greek fiscal position and how much the government is willing to adjust its 2015 budget. While 31 December is the official deadline for a deal on the last instalment of the bail-out program, negotiations could continue into January.

The loss of sovereignty that came with the bail-out loans is despised in Greece. The latest opinion polls suggest that if there were an election now, the opposition party, Syriza, would become the largest party in the parliament and could form a coalition government. And that might happen soon. The current President's term ends early in 2015 and the Government must nominate a candidate able to muster the support of 180 out of 300 members of  parliament. The coalition government of New Democracy and Pasok do not have enough members of parliament to get their candidate elected by their own votes. Syriza has said that they will vote against any candidate proposed by the government, and it is likely that smaller parties and independent members of parliament will conclude the same. Matters are supposed to be settled in February, but the process may be speeded up.

If the government's candidate is not elected, the constitution will call for a snap parliamentary election, most likely in March. This will probably result in a Syriza-led, leftish coalition government.

Syriza, while no longer openly threatening to exit the Eurozone and having become more moderate as it has gained in popularity, is a left-wing party that is staunchly against bail-out conditionality. If they come to power, they will probably try to yet again increase the size of the public sector and play a tough hand in negotiations with the Troika.

Syriza is left wing, but contrary to how the party is often portrayed in international media, their leaders, unlike those of the neo-fascist Golden Dawn, are not an irrational lot. It is our impression, after having met Syriza advisors and analysts in Athens some weeks ago, that one needs to distinguish between rhetoric and politics. Syriza is probably going to pursue more or less the same ideological program as Pasok, i.e. the social democratic party that before the crisis alternated with the conservative new democracy in ruling Greek politics. The reason is that it is mainly frustrated Pasok voters that will potentially hand Syriza executive power. While frustrated Pasok voters are searching for another policy, they will not vote for a populist left-wing turn of Greek policy. Hence, while the unions and the pensioners will benefit, further privatization will stop, and tax rates on the rich will increase, Greece is not going to turn into a Eurozone socialist enclave.

Greece will become more social-democratic, however. One may argue that the main problem in Greece since the early 80s has been has been a misguided effort to adopt a Scandinavian tax-and-spend policy without having the same civic virtues – like paying taxes – that have underpinned the Scandinavian model. Nonetheless, trying to blow oxygen on a Greek version of the Scandinavian model is not going to speed up Greece's recovery and it will lower the long-term growth outlook for Greece.

However, for investors in Greek sovereign bonds the pressing issue is how negotiations between a Syriza-led government and the Troika will play out. My understanding is that while the negotiations are going to be troublesome, the two parties will eventually end up with an agreement.

The point is that the large countries in the EU, and those on the board of the IMF, will do their utmost to keep Greece within the Eurozone. A Grexit could be a prelude to a collapse of the Eurozone, especially if the Eurozone's economy is barely growing and left and right-wing populists gradually gain power in other capitals. If the Eurozone collapses, the future of the EU and the four freedoms will be at stake. Risking tearing down the basic institution built up after the Second World War to ensure peace, prosperity and brotherhood among Europeans just to teach the Greeks a lesson is out of the question. Hence, the Troika will probably offer Syriza-led Greece leaner terms – lower interest coupons, extended maturity and a precautionary credit line without an official "memorandum of understanding". Depending upon the fiscal policies of a new government – their chief economic spokesman has said that the days of budget deficits are a foregone era – this might then be followed by a significant cut in the interest rate on Greek government bonds.

We are not there yet, however. The current situation is uncertain. The value of Greek government bonds is likely to fluctuate over the coming months, and we judge the likelihood of increased political turbulence and a spike in yields as higher than the probability of less turbulence and lower yields. (The 10-year bond currently yields 8.17 percent).

Nevertheless, if our analysis is correct, this is going to be a temporary situation. The Greek sovereign might eventually be an attractive debtor again. Hence it could be just a matter of time before we once again dip our toes in Aegean water.

In SKAGEN money never sleeps: The proceeds from Tellus' sale of Greek bonds were initially used to purchase more short US debt and then to increase our holdings of Portuguese and Italian bonds. The ECB's QE whispering is getting louder and louder. Proportional purchase of sovereign debt will probably be a reality in Q1. That will further depress yields in the Eurozone. This will have an effect on Greek bonds too – when the political dust has settled in Athens.