Europe's sovereign debt crisis has roiled markets over the past few months. Investors worry that multiple countries, led by Greece, will default on their bonds -- billions of which are held by banks around the world. As our chart of the week demonstrates, I believe this hypothetical concern will soon become a reality. The issue is no longer if Greece will default, but when.
A textbook yield curve
A yield curve plots the yield, or interest premium, paid by a country on debt of differing maturities. Our government, for example, currently pays interest of 0.03% on a six-month bond, 0.19% on a two-year bond, 2.03% on a 10-year bond, and 3.32% interest on a 30-year bond.
As you can see, the interest rate a government pays generally increases with time. This represents the higher risk of default on a 30-year bond relative to, say, a six-month bond, since there's more time for things to go wrong.
A properly functioning yield curve will accordingly take the following upward-sloping form:
Source: U.S. Department of the Treasury.
The dreaded inverted yield curve
But Greece's yield curve doesn't follow these rules. As the chart below reveals, its yield is higher on short-term maturities and lower on long-term maturities.
Source: Bloomberg.com.
Bond traders already assume that Greece will default. And when it does, its short-term bonds will be the first to go -- which explains why the yield on its one-year bond is 130%, whereas the yield on its 30-year bond is a comparatively modest 15%!
What does this mean for you?
The potential for a Greek default has been pushing down bank stocks around the world, including Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Wells Fargo (NYSE: WFC), as investors fear banks' exposure to Greek bonds. An actual default, if and when it comes, could create further bargain opportunities among stocks -- particularly financials.
And should investors flee Greece's collapse by moving into traditional safe havens like Treasuries, gold, and silver, profitability should improve at precious-metal mining companies like Yamana Gold (NYSE: AUY), Silvercorp Metals (NYSE: SVM), Silver Wheaton (NYSE: SLW), and Endeavour Silver (NYSE: EXK).
In either case, investors will be rewarded as much for their temperament as for their intellect. This could be a bumpy ride. To keep an eye on the ups and downs of the stocks discussed above, just click here to add them to your watchlist.
