"We think the ramifications of a Greek exit are more serious than the market anticipates", is how Morgan Stanley starts their European strategy report this week. They have raised their probability of a Euro break-up to 35% but the most likely outcome they foresee is a Euro divorce with Greece's exit preceded by strong contagion via three main transmission channels: the sovereign, the banking sector, and the political situation. Italy, Spain, Ireland, and Portugal are unsurprisingly the most at risk of material contagion and they recommend investors stay positioned defensively across risky assets as we remain in the 'Crisis' stage of the so-called C.R.I.C. cycle - and they note that unlike so many knife-catching US equity and Italian bond buyers [9], it is not sensible to try to pre-empt the Response phase of C.R.I.C. cycle. There appears to be four scenarios (and evolutions) for the future of Europe (from Renaissance to Divorce with Staggering On and an awkward 'Italian Marriage' in between) and we drill into the four additional possibilities under the divorce scenario for insight into the effects various risky asset classes will feel in each case.
The Four Eurozone Scenarios...
[10]
and the CRIC Cycle...
CRIC stands for Crisis-Response-Improvement-Complacency
[11]
And the various risk catalyst events in the next few weeks...
[12]
Which lead to the following Possible Evolution of Events - and Key Signposts...
[13]
With the four increasingly dismal scenarios underlying the Divorce Scenario as follows:
[14]
and the impacts of these four Divorce Scenarios...
[15]
Source: Morgan Stanley