It seems the clarion call for central bank intervention to save us all is growing louder as following Citigroup's imploring letter earlier in the week [9], SocGen has done its homework on the impact of a Greek exit from the Euro and finds Euro Stoxx could drop by 50% under a contagion scenario. They believe the reason why the eurozone market is holding up relatively well - despite the rising risk of a Greek exit - is that contagion has not really spread yet, which is then 'discounted' away based on expectations of a central bank put to save the world. In the case of a disorderly break-up (the only kind there can be realistically in our view), they expect eurozone profits to decline for two years, a rise in bond yields (raising cost of funds), a rising equity risk premium, and the implicit drop in P/E multiples. A Greek exit alone (with no contagion) would likely knock 10% off Euro Stoxx but the significant rise in correlations across the euro-zone suggests the idiosyncratic becomes systemic very rapidly.
European market ex-financials has held up relatively well...
[10]
but risk of contagion is dramatically high considering the correlation in the euro-zone...
[11]
In order to profile the impact of a Greek exit on the DJ Euro Stoxx 50 SocGen imputes:
- a profits growth decline for two years after restructuring as a result of lower consumption and fiscal tightening in countries remaining in the eurozone,
- euro depreciation vs the dollar,
- a rise in bond yields due to risk of default, partly offset by recession fears,
- a domino effect which is proportional to correlations we showed on the previous page,
- a rise in the equity risk premium.
Once the potential level of this year?s euro profits is recalculated using our top-down regression model, we input the result into an earnings yield equation to get the DJ Euro Stoxx 50?s sensitivity to both rates and profits. Should profits fall 20%-30% and yields widen 100bp-200bp, we find the DJ Euro Stoxx 50 could lose up to 50% of its value at 23% in the best case and 45% in the worst.
With a 50% drop possible and 10% probable if Greece leaves...
[12]
with various scenarios as follows:
[13]
Source: SocGen