The way information is presented to us influences how we think about it.
This idea is known in behavioural finance as ‘framing’, and like many lessons from behavioural finance, can be filed under the heading of ‘stating the obvious.’ But it is so obvious that we forget it, particularly when we are under stress.
And so it is with Greece at the moment. We might be aware that the nature of media reports influence how we feel about risk, but that doesn’t stop us worrying.
Not only does Greece dominate in terms of the amount of coverage, but the coverage itself has a greater impact because there is a strong emotional element running alongside the facts. Human beings overweight the odds of bad things happening when we can picture them, and the media in Europe is currently providing plenty of pictures.
We are shown photos of men and women, usually elderly, queuing outside banks. We see young protestors on the streets echoing images of past struggles around the world.
And on top of this we are given a cast of characters: the motorcycle-riding finance minister; the uncompromising German Chancellor; the faceless suit wearing bureaucrats, who form a kind of soap opera. This personalised and emotive picture appeals to the human love of narrative.
No wonder clients have asked us more for our views on Greece (2% of Euro Area GDP) than vastly larger, but more boring issues.
The way in which the Greek situation is presented also impacts our perceptions in terms of ‘path dependency;’ the idea that the route we have taken to get somewhere affects how we feel about the ultimate destination.
The fact is that an equity investor in Portugal has made 13%, in Italy 10%, and in Germany 8%. However, if you are like me, you will feel very different about that figure today (figure 1) than you would if the journey had been more pleasant (figure 2).
This may seem like a ridiculous exercise but it highlights an important point: if given the same facts, markets had looked more like figure 2 than figure 1 would you be more or less worried about Greek risk today? Is it the change in fundamentals that are worrying us, or the price action?
Contagion: ‘We Go Together’
The tendency of human beings is to believe we don’t fall victim to biases such as ‘framing’ or ‘path dependency.’ We tell ourselves that we are above these things, that we have read the Financial Times, Handelsblatt, or Les Echos, and know that it is the facts that we are worried about.
‘Yes Greece is small’ we tell ourselves ‘but it can lead to bigger problems.’ European banks are exposed to Greek debt. If Greece leaves the Eurozone, so might others.
Reacquainting ourselves with these facts might be helpful.
First, the exposure of European banks to Greek debt. The subprime crisis revealed problems establishing exactly what banks have exposure to what, but the general consensus is that European banks have been reducing their Greek exposure, a lot.
The below shows data from the Bank for International Settlements. The first thing we note is the huge reduction in exposure after 2012 (France being the most notable).
These are still big numbers, but are worth putting into context. The UK’s exposure is around $12 billion. In April Standard and Poor’s estimated that the UK’s big four high street banks alone could face another $29 billion (£19 billion) in fines and litigation before the end of 2016.
As for contagion to other sovereigns, that is highly unpredictable. Governments can be vulnerable to runs just as banks are and this is highly dependent upon confidence, but the moves in peripheral bond yields so far have been muted, (see figure 4) suggesting that markets aren’t too worried about the prospects for peripheral debt. As of yesterday (7 July 2015) Italian, Spanish and Portuguese bonds have rallied while equities have declined.
Perhaps even more uncertain is the likelihood that a shift in political will would cause another nation to leave the Eurozone. Public opinion can shift violently, particularly in times of hardship. However, as we have noted in previous posts, most countries in Europe have been showing signs of recovery (as had Greece until brinkmanship took centre stage). It would seem there is currently little incentive to risk these advances with the chaos associated with a new currency.
A recurring theme here in noise corner is the examination of whether the true motivations for our market concerns are fundamental or emotional. A casual scroll down the posts in this section of the blog in the short time it has been running reveals that, more often than not, it is the latter. Many of our posts were on issues that seemed deeply important at the time, but hardly show up on a price chart when we look back today. This will not always be the case but being honest with ourselves about what is truly causing us concern will be the best way of ensuring we have the discipline as investors when there is a genuine issue.
In the case of Greece there are many unknowns but we can observe the forces that may make us worry more than we should, and also point to those facts which should give us comfort. There are deep problems in Greece which will mean suffering on a human level for many, but this should not influence the decisions of most investors.