It's time to stress-test all of the companies in your portfolio.
It's crucial to determine their geographic exposure right now,
because a handful of major economies are possibly headed for a
Each of these countries is beset by stunningly-large budget
deficits, unfavorable demographics, a too-strong
and weakening consumer demand. Before things get better (and they
will) they may get a lot worse during the next few years. A
portfolio with exposure to these economies may
I'm talking about four of the 12 largest economies in the world,
which accounted for a combined $11 trillion in economic activity
last year. That's 35 times larger than Greece, to put things in
perspective. Simply put, U.S. companies with exposure to these
economies will need to shrink their operations in these trouble
spots, lest they see spiraling losses in coming years.
The four countries in question: Japan (the world's No. 3
), the U.K. (No. 6), Italy (No. 8), and Spain (No. 12). Let's take
a closer look.
Roughly 18 months, I laid out
the sobering challenges this country faces
As this chart shows, the yen has rallied against the dollar, from
$1.20 to a recent $0.81 during the past five years (meaning, one
yen was worth $1.20, and is now worth $0.80).
A strong currency always impacts trade flows. And Japan generated a
in 2011 for the first time since 1980, thanks to the rising yen. At
this point, it's hard to see the country again becoming a
as long as the yen stays strong, especially now that the country
has decided to de-emphasize nuclear power rely on massive amounts
of imported oil and natural gas.
In response to the strong yen, major Japanese exporters such as
have begun the process of closing domestic factories and expanding
capacity abroad. Japan has always been a nation of nearly full
employment, with most citizens contributing to the tax base.
Looking ahead, unemployment looks set to rise and
receipts may steadily fall without structural reform.
This comes right at a time that Japan is rapidly aging. As many
citizens retire, they are creating a fiscal drag on the government
as benefit spending surges. Adding insult, the government has been
forced to spend billions on reconstruction in the area devastated
by last year's tsunami.
Thanks to years of overspending on roads and bridges that were
simply political pork, Japan already has the highest debt-to-GDP
ratio of any country in the world, with its borrowings equaling
close to 240% of annual
. The country has always benefited from a strong domestic savings
rate, enabling the government tooffer very low interest rates on
the debt. But as more consumers head into retirement, Japan looks
set to pay steadily higher rates to find new buyers of existing
debt as it gets rolled over. Until this downward spiral is
resolved, Japan's economy will get worse before it gets better.
2. The United Kingdom
A decision to cut spending in the face of a staggering
seemed like a wise move in the U.K., but it was done at a time when
the economy was on very tenuous footing. As a result, sharply
reduced government spending threatens to turn a weak economy into a
shrinking economy as negative feedback loops spread across various
sectors. For example, weaker consumer spending leads to reduced
government tax receipts, which leads to even weaker government
International Monetary Fund (
had been hopeful that the U.K. economy could grow a modest 0.6% in
2012, but that forecast was made before it was reported that it
shrank 0.2% in the fourth quarter of 2011. The odds are rising that
the economy will continue to contract, making it harder for the
government to collect sufficient tax receipts to make a meaningful
dent in the government's finances. And the U.K. can't export its
way out of this mess: The country's industrial sector is largely
uncompetitive, which explains why the U.K. has run trade deficits
every year since 1997. This is a country that is wobbling now, but
could easily enter into a downward spiral with a few bad breaks.
These countries both suffer from aging populations, distressed
consumer spending as a result of high unemployment (a stunning 23%
in Spain), and look hard-pressed to reverse their debt woes as long
as they are tied to the strong euro. More efficient economies such
as Germany are simply too advanced for Spanish and Italian
companies to gain a foothold in many European economies.
Italy has announced far-reaching austerity plans, which may create
the scenario outlined in the U.K.. And concerns are rising that
Spain's targeted budget cuts won't materialize, perhaps turning
this country into Europe's next troublespot . The Spanish economy
is 450% larger than the Greek economy, and the risks of a financial
mess are that much larger for the beleaguered European economic
Risks to Consider:
It's hard to find "upside risks," meaning catalysts that will
materially improve the fortunes for these countries.
Action to Take -->
A wide range of companies in the S&P 500 relies on these
countries for a decent chunk of their sales. Japan, in particular,
is a huge market for the likes of
Tiffany & Co. (NYSE:
and so many others.
The U.K., Italy and Spain account for roughly 35% of Europe's
economic output, but key trading partners such as France and
Germany would also feel the pain of deep economic retrenchment in
these countries. You can find the degree of
to these countries by perusing the annual reports of the stocks you
filings sent to the Securities and Exchange
at the end of each
). If any of the stocks you own has considerable exposure to any of
these countries, then you'll need to reassess whether it belongs in
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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