Setting Up Your Portfolio for the Greek Elections

Heading into Sunday's Greek elections, world markets have been moving higher. For the week, the S&P 500 is trading up a little less than 1%. A modest rally started on Thursday and has carried over into Friday. The catalyst for the move higher in stocks, despite the steep risks posed by this weekend's elections, has been commentary from global central banks who stand ready to provide liquidity in the case of financial market turmoil. On Friday, European Central Bank president Mario Draghi said that the ECB will continue to inject liquidity into banks where it is deemed necessary. “The ECB has the crucial role of providing liquidity to sound bank counterparties in return for adequate collateral. This is what we have done throughout the crisis ... and this is what we will continue to do,” Draghi said. The ECB president's assurances come on the heels of a $124 billion lending program unveiled by the Bank of England. In return for collateral, the central bank will lend money to institutions in need of liquidity. Furthermore, the Bank of England said that it will activate an unused facility which will put at least 5 billion pounds a month into the financial sector. In December and again in February, the ECB provided unlimited three-year loans to European banks. This added more than $1.26 trillion into the financial system. Similar actions could be taken in the case of significant turmoil in markets after the elections in Greece. “In times of increased financial instability, ‘adequate liquidity' indicates a volume of central bank money that also counteracts a temporary inability of banks to refinance in the market, which could lead to systemic consequences for the banking sector as a whole," Draghi added. If significant central bank intervention is needed, global central bankers seem prepared to take coordinated action. Bank of Japan Governor Masaaki Shirakawa also said that the BoJ is ready to take any necessary measures to counteract market turmoil. "There are no cunning steps to achieve financial system stability, he told Reuters. "An orthodox step would be to provided liquidity. We have the means to provide our own currency and foreign currencies. It would be important to supply abundant liquidity to calm worries." In Greece, where official polls are banned two-weeks prior to elections, the race between the leading parties is still too close to call. Elections held on May 6 in the stricken country failed to produce a clear winner, hence this weekend's vote. In order for a new government to be installed, it needs to have at least 151 of the 300 seats in the Greek Parliament. The party with the most votes is awarded a bonus of 50 seats and the remaining 250 seats are distributed proportionally by the percentages obtained by parties that received at least 3% of the vote. The leading parties are the center-right New Democracy, led by conservative Adonis Smaras, and the Coalition of the Radical Left or SYRIZA party, headed by 37-year-old upstart Alexis Tspiras. In final published polls in Greece, the New Democracy party, which supports keeping Greece in the Eurozone, had between 22.7 and 26.1 percent support. SYRIZA, which has espoused anti-austerity, anti-euro rhetoric, was polling between 20.1 and 31.5 percent. In the May vote, SYRIZA garnered 16.6 percent of the vote, but support has been rising for the party as conditions continue to deteriorate in Greece. According to reports, Tspiras and SYRIZA may be softening their stance on remaining in the EU, saying that he remains open to "discussion" on the bailout terms for the debt-stricken country, if European leaders are willing to meet Greece in the middle. The Daily Beast quoted him as saying "If they say 'no' to everything, it means that they want the end of the Greek people and the euro. If Greece doesn't get its next loan installment, the Eurozone will collapse the next day." Severe austerity measures implemented in the country in return for bailout funds have choked the Greek economy and caused significant hardship throughout the country. Nevertheless, a recent poll shows that 8 out of 10 Greeks would like to stay in the Eurozone. The Daily Beast reports that a return to the drachma could make things even worse, leading to the rationing of food, fuel, and medical supplies while the new currency system is put into place. Heading into the weekend, investors across Wall Street are positioning their portfolios for what could be a very volatile upcoming week. Large money center banks which will be impacted by European sentiment are trading mixed, with Citigroup C and Wells Fargo WFC trading lower and Bank of America BAC and JP Morgan JPM rising. Large European banks like Credit Suisse CS, Deutsche Bank DB, Barclays BCS and UBS UBS are all moving strongly higher on the session in the wake of the comments from the ECB and a 0.20% gain in the EUR/USD. Traders also appear to be moving money into higher risk sectors with consumer cyclicals, basic materials, energy, and financials substantially outperforming less risky sectors like utilities and consumer staples. Nevertheless, the prudent move heading into the weekend might be to rotate into high dividend, domestic stocks. This strategy will allow investors to capitalize on a relief rally next week while also protecting their downside. While most large-cap American stocks have European exposure, they should outperform most areas of the market in the case of a large sell-off in risk assets. Names like Proctor & Gamble PG, Wal-Mart WMT, Pepsi PEP, and Altria MO could be good places to rotate into going into the elections. Bank of America's Merrill Lynch unit released a report attempting to handicap the potential outcomes of the elections. Their base case scenario is that Greece will form a pro-EU government and there will be a limited policy response by EU policymakers. Under this scenario, which they view as likely, there could be a strong relief rally in risk assets starting next week. The upside, however, will likely be limited as Spanish worries continue to weigh and investors re-establish short positions at higher prices. The bull case presented by the analysts is that the Greeks do not form a pro-EU government and there is a significant, coordinated, policy response in Europe. In this event, which they do not view as likely, risk assets might be initially sold-off as fear levels spike, but the response from policy makers would be significant enough that a strong rally ensues. In such a scenario, cyclical stocks with European exposure could be among the leading areas of the market as investors react to massive liquidity injections in the Eurozone. The bear case that the analysts present (low to medium probability) is that Greece does not elect a pro-EU government and there is a limited European policy response. They think that this scenario would cause the Federal Reserve to act quickly and implement more quantitative easing, which might limit losses in the U.S. stock market, with the S&P 500 falling around 5%. Defensive, domestic stocks should outperform along with higher quality names under this outcome. With slightly under two hours left in the trading day, investors have precious little time to adjust their portfolios. Volume may continue to be elevated going into the closing bell.