When it comes to handling the deepening European economic
crisis, policy planners have no playbook. They're winging it,
coming up with repeated incremental steps to try and limit the
spreading contagion. Thus far, they've failed. An increasing number
of countries can't seem to weather the storm on their own, yet
there are clear limits to how much the stronger European countries
can really help. In a worst case scenario, the economic crisis may
deepen much further in the first half of 2011. Make no mistake,
U.S. investors won't be insulated from Europe's problems.
Here's what you need to know…
A tale of two regions
The myth that Europe is one big economic zone is starting to come
undone. France and Germany just reported notable increases in
employment, while southern neighbors showed big spikes in
unemployment. It wasn't supposed to work that way. The decision to
create an economic union and a common
was expected to lead to balanced and mutually beneficial growth.
Instead, the stronger countries are pulling away from the pack and
the weaker countries have started to move into a self-reinforcing
cycle of negative economic growth.
Why do those employment trends matter so much? Because they set the
stage for future economic activity. It's increasingly clear that
southern Europe is set for even weaker economic results in 2011,
and the current round of financial rescue packages could continue
-- and grow larger.
Greece's problems spooked the market. Ireland's fiscal woes are
just now hitting the headlines. And pretty soon, Spain may be the
biggest troublespot . The Spanish
is far larger than some of its
peers (Portugal, Ireland, Italy, Greece and Spain), and a bailout
for Spain would really test the mettle of policy planners in
Brussels, Berlin and Paris.
Moody's downgraded Spanish debt in September and has just signaled
is likely. The ratings agency is not anticipating debt defaults in
Spain just yet, but it also doubts that the country can pull
through unless it imposes even greater austerity on its budget.
Remember those protests in England during the past week? Look for
more of them in southern Europe in coming months as the belt
The risk of austerity
Belt-tightening is necessary and to be applauded. But it runs real
risks. What if spending cuts are so deep that these economies
shrink even more? And with smaller economies, how will these
countries generate the tax revenue needed to start paying back all
of their borrowings? The United States' stimulus approach, which
some like and some don't, at least had the virtue of nudging the
economy along. You can debate the risks to long-term deficits that
stimulus program entails, but the U.S. economy may have had even
higher unemployment levels without those efforts.
In Europe, they are going the other way, by quickly shrinking
governments. The long-term logic is sound, but the short-term
impact is very risky. If these southern European economies indeed
contract again in 2011 as belts tighten, this financial crisis
could meaningfully deepen.
What it means for us
Right now, U.S. multinationals are keeping a close watch on
European events. Companies ranging from
Oracle (Nasdaq: ORCL)
Procter & Ganble (
do a significant amount of business in Europe.
Their fourth-quarter results are unlikely to feel too much impact,
especially since the all-important French and German economies are
holding their own. Countries like Italy, Ireland and Portugal don't
represent a meaningful chunk of business to most U.S. exporters.
But the U.K. and Spain do. And it's those countries that could go
either way in 2011. If they slump in 2011, which now looks
increasingly likely, then U.S. multinationals will feel the pain.
These firms are also watching the euro. The currency fell to $1.25
during the summer but has rebounded to a recent $1.33. That's a
level multinational firms can tolerate. But if this European debt
crisis deepens, it's hard to see how the euro can avoid further
weakness. If it moved closer to $1.20, multinationals would start
to take a hit as repatriated profits are diminished and
Europe-based rivals gain a price advantage. And a move below $1.20
is certainly not out of the question.
Of greatest interest to U.S. investors, you'll need to be concerned
about instability. The stock market hates it. If Europe's troubles
deepen and any country inches closer to default, many stock
markets, including those here in the United States, could take a
quick deep hit. For that matter, any deepening social unrest in the
austerity countries is likely to be greeted warily by U.S. traders.
Action to Take -->
Wall Street is like a herd of cattle. Investors decide to ignore or
focus on issues of their collective choosing -- a classic case of
groupthink. Right now, the rising U.S. markets imply that investors
are unperturbed about events in Europe. But once the herd pays
attention, it could quickly morph into a lot of hand-wringing about
what could go very wrong in Europe in 2011.
It pays to watch events very closely. And it pays to hear what U.S.
multinationals have to say -- especially if you own stocks of
companies that do a significant amount of business in Europe. The
crisis is unlikely to impact their fourth-quarter results, but
their outlook for subsequent quarters may sound much more
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.