Today at TILE we talked about how quickly information spreads in the market and the impact one piece of news can have across seemingly unrelated markets. Why did concerns about Greek debt lead to a drop in the U.S. equity market this week? What is the relationship between markets (whether debt, equity, foreign exchange, or commodity markets) and across geographies? And why do markets seem to behave like dominoes, or a “wave” making its way along the shore?

Last week, the European debt market raised concerns about countries like Greece, Spain, Ireland, and Portugal defaulting on their debt (although Greece was the primary target of concern). As we’ve discussed in other blog posts, sovereign debt (the debt issued by a country versus an individual) is backed by the credit-worthiness of the whole country. Their credit-worthiness or rating is determined by how the funds will be used and the country’s ability to repay. At present, Greece has been issuing debt for the purpose of stimulating the economy (government projects, job creation, etc.), however some experts are concerned that this stimulation isn’t that stimulating and Greece will not be able to pay back their loans.

While this is common for still-developing countries in South America, Central America or Africa, it isn’t that common for a European nation – and particularly one that is a part of the eurozone. The eurozone was created so that individual countries in Europe could create economic advantages by banding together on economic policies (plus share a currency and interest rate policy). That being said, it isn’t clear if other members of the euro community will “back up” the euro by saving Greece from defaulting on its debt. It is kind of like micro-lending to small groups. If one member doesn’t repay her loan, then either the other members of the group must cover her responsibilities or risk the future reputation (and borrowing power) of the entire group. Another example might be a group project for school. If one team member doesn’t do his share, the rest of the team can either do his work or risk getting a really bad grade.

Beyond issues of responsibility, what happened last week (and what happens all the time) is a shift in investor expectations. Investors, particularly good investors, are constantly taking information about one piece of the market and using that to set expectations about other pieces of the market. How investors interpret information and set expectations determine how and why concerns about one country’s debt can spread like a wild fire across continents and markets.

While this isn’t a complete analysis, you can get an idea of how investors’ minds may roam: Concerns about Greece defaulting on its debt leads investors to question how this will impact the value of the euro; if investors think other countries are unwilling to back up the obligations, the value of the euro will change (for the worse) and there is a change in the foreign exchange market (the euro falls in value compared to other currencies like the U.S. dollar or Japanese yen). Furthermore, if Greece is not able to stimulate its economy fast enough, does that mean all of Europe is growing slower than expected? (This thought leads to the European equity market falling in value as investors reassess growth trends there in the future); if Europe is growing slower, then that could impact U.S. companies dependent on selling product in Europe (and the value of the U.S. equity market falls as investors reassess growth trends here in the future). And if Greece or any other eurozone country can default, then maybe other countries will also be defaulting (the value of other sovereign debt falls as investors sell “more risky” debt); this impacts the foreign currency market even more as investors swap sovereign debt in Europe for debt in the U.S. or Asia. Are you getting the picture? Just like a line of dominoes, the consequences of one action in the world market can continue and on and on…

So what does this mean for the TILE community? Mostly, it means that all investments are interconnected. Simply owning a U.S.-based company focused on green technology may not make you immune to changes in foreign exchange rates, consumer demand in other parts of the world, or general expectations about the market. For example, what if that green technology company sells its products mostly in Europe? The value of the sale changes with the value of the foreign exchange rate between dollars and euros, and suddenly demand is slowing because the unemployment rate is going up on another continent! When you set your own expectations for investments, or anything in life, you should recognize that we no longer live in a simple financial world and we may need a wet suit, at times, to deal with all the waves.

- Amy