Risk Of European Contagion Exaggerated?
It’s no secret Europe is struggling with a severe sovereign debt and banking crisis. The story has been a news media staple since late 2009. You probably remember seeing more than a few articles about Europe’s PIIGS over the past couple of years.
Until recently, it looked like Europe was having success in containing the crisis. Two of the PIIGS, Portugal and Ireland, received bailouts from the EU and avoided defaulting on their debt. Both economies are now on their way to healing themselves.
But one of the PIIGS hasn’t been so fortunate… of course, I’m talking about Greece. The Hellenic Republic’s woes have dominated the headlines in recent weeks.
Greek citizens have been rioting on and off for months. They’re angry about harsh austerity measures imposed on the country by the EU. Many Greeks believe the EU is sacrificing the country’s future in order to preserve the continent’s flimsy union.
And the issue came to a head last week…
With Greece on the verge of default, EU leaders and the Greek government appeared to reach an agreement that would save the country and preserve the EU. But then out of nowhere, Greek Prime Minister George Papandreou announced last week he would submit the proposal to a popular vote.
The news sent global markets into a steep tailspin.
It’s clear to everyone (except maybe Mr. Papandreou) that if the deal is put to a popular vote, it’s dead in the water. And with it, Greece’s hopes for an orderly resolution of their debt crisis and the EU’s hopes of preserving their union.
But late last night, Greece pulled back from the brink.
A deal was struck among the nation’s various political parties that would sack Papendreou and put an interim coalition government into place. The coalition will ensure the new EU debt deal and then lead Greece to formal elections early next year.
As you might expect, a number of pundits are now sounding the all clear signal.
The most prominent one being Chairman of Goldman Sachs Asset Management, Jim O’Neill. He recently said, “[t]he contagion from Europe to the US and China as the two key engines of the world is being exaggerated.”
Well, pardon me if I politely disagree…
Europe is sliding headlong into what will likely become a long, drawn out recession. Just as a solution to Greece’s problems is being put into place, Italy is moving to the forefront of the ongoing EU crisis. And a default by Europe’s fourth largest economy would have catastrophic consequences for the EU and the global economy.
We’ll have to wait and see how that drama plays out before we can truly gauge the effects. But one thing’s for sure, with more austerity on the way, a recession in Europe is a done deal.
The big question now is will the coming European recession be severe enough to pull the entire global economy down with it. Mr. O’Neill believes growth in China and the US will counteract Europe’s recession and prevent the global economy from completely falling apart.
But I don’t see how that’s possible.
Europe is one of China’s biggest end markets. As manufacturer to the world, China’s economic growth is almost entirely dependent on exporting goods overseas. And Europe is their second largest market behind the US.
As Europe slips deeper and deeper into recession, demand for Chinese goods will drop dramatically. This means China’s headed for a big drop in export revenues, which could lead to a slowdown in Chinese manufacturing activity.
The same can be said for the US…
Europe is America’s largest trading partner… about 20% of all US exports go to Europe. Several industries are heavily dependent on exports to the Old World, including chemicals, transportation, computers, and electronics. Companies like Microsoft (MSFT), Hewlett-Packard (HPQ), and Boeing (BA) are invested big time in Europe.
As Europe slides into recession, we can expect a big drop in orders for computers, aircraft, and other goods. And the effects will likely ripple through the American economy.
Bottom line…
Be careful when investing in US multi-national companies with large exposure to Europe. Many of these companies stand to take a hit to revenues and earnings in coming quarters. And if we start seeing downward revisions to analysts’ estimates, we could easily see these shares sell off.
Category: Stocks
