How will stocks react in a disorderly Greek restructuring?

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Demonstrators clash with riot police outside the Greek Parliament on June 29, 2011 in Athens during a 48-hour general strike

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Jonathan Ratner Sep 19, 2011 – 10:54 AM ET | Last Updated: Sep 19, 2011 9:27 PM ET

In the event of a disorderly Greek debt restructuring, the S&P 500 would likely drop roughly 15% from current levels to 1,020, according to a new report from Barclays Capital.

Barry Knapp, head of U.S. equity strategy at Barclays, continues to incorporate an orderly restructuring into his forecasts. However, he warned that the probability of the European crisis deteriorating further is greater than the economic and policy pieces falling into place. That would include the macroeconomic outlook stabilizing, the Fed easing policy further and the public policy outlook improving somewhat.

Mr. Knapp cut his 2011 year-end price target for the S&P 500 to a still-optimistic 1,325 from 1,450.

Even if the Europeans let the situation get considerably worse, the strategist expects there would be a significant global policy response to an intensification of the crisis.
He cited the recent ECB dollar funding swap announcement as an example.

“If, for example, Greece were to default later this year (and financial conditions deteriorated significantly), it is likely that the ECB would cut rates, the Fed would restart large scale asset purchases, the French Finance Ministry would inject capital into their banks and the Germans would have enough cover to convince the public that a tighter union was necessary,” Mr. Knapp said.

“While the S&P 500 would likely rally following those policy actions, investor concerns about a recession would increase sharply and equities would likely go lower first; the question is, of course, how much lower.”

A disorderly Greek debt restructuring is the obvious candidate to push the United States back into recession, or a least convince investors this is the case.

If that occurred, Mr. Knapp believes investors would anticipate S&P 500 earnings in 2012 would drop to roughly $85. That would drive the index’s P/E multiple down to 10.7 and the S&P 500 down to 1,020.

If the aggressive policy response then partially convinced investors a recession could be
avoided and earnings would be flat in 2012, Barclays’ model suggests a 12 multiple on trailing earnings given the rebound. This would put the S&P at 1,150, not far from where it is today.