During this latest iteration of the Eurozone existential crisis, we’ve dropped from 1350 on the S&P 500. We’ve visited 1074 and seen 1284, both within weeks of one another. We now seem to be generally moving sideways, but bouncing between 1215 and 1270.
What is the market saying? This trading pattern says to me that the market is highly emotional but no one has a clue to figuring out what’s going on in the Eurozone.
thoughts on Euroland
As a first step toward developing a (hopefully) intelligent stance to take toward the Eurozone in building an equity portfolio, I thought I’d try to list the points I feel confident about. That may be enough for me to use; at the very least, I may be able to highlight what other information I really need to know.
1. Matters would be worse on Wall Street if the US economy weren’t recovering. While not thrillingly optimistic, the view of Jim Paulsen, Wells Fargo’s chief investment strategist, is an interesting–and, to me, a completely plausible one. He terms the current sluggish recovery as normal for the US in today’s world. It only looks bad when we compare it with recoveries from thirty or forty years ago, when economic circumstances were very different.
2. The Eurozone won’t be generating much economic strength for years, I think. If so, as investors we should regard Europe as a special situations market and be very choosy about what stock we own. If we take it as given that we don’t want much exposure, our biggest concern has to be that the economy there gets bad enough that it punches a hole in the bottom of the world’s economic boat.
Why do I think European prospects are dim?
–Japan hid the banking problems that resulted from its late-1908s speculative bubble for a decade. Its economy stagnated during that time.
–The US fixed the worst damage to its banks almost immediately and the economy began to perk up 18 months later.
–Euroland? So far, it has followed the Japanese example. The result has been little growth and creation of the only negotiating chip places like Greece and Italy have. Even if the EU recapitalized its banks tomorrow, we wouldn’t see the positive economic effects until 2013, at the earliest.
3. Euroland’s investment importance comes from the accumulated wealth its citizens hold, not its size or growth prospects.
Look at the Eurozone’s (small) size.
Using Purchasing Power Parity calculations from the World Bank (I got them on Wikipedia), global economies break out as follows:
Brazil, Russia, India, China 25% of the world
US, Canada, Mexico 23%
rest of EU 5%
everybody else 26%.
I draw two conclusions from this list:
–Euroland isn’t that big in world terms any more. The fate of the “other” 85% is hugely more important than what happens in Europe.
–One possible outcome for the Eurozone is that it fades into insignificance in the way that Japan has during the past two decades. I’m not sure this is the most likely outcome, but it’s a good possibility. After all, the EU has many of the same cultural rigidities that have helped to sink Japan, and it hasn’t fixed its banking system. Japan’s economic collapse didn’t stop the 1990s from being a very profitable decade for investors elsewhere.
4. The worry isn’t a deep recession in Europe–it’s uncertainty about unanticipated consequences. At least, I don’t think it should be about Eurozone recession. According to the Conference Board, a US-based economic consultant, the world is likely to grow by about 3% in real terms (that is, after subtracting inflation) in 2012. The agency thinks the EU is most likely to grow by 1%; its “pessimistic” scenario has the area little better than flat for the next half-decade.
What does Europe mean for overall world economic expansion, in the Conference Board’s view? Realistically, nothing. In the base scenario, the EU chips in .15% to world growth–more or less a rounding error.
Let’s assume that somehow the bottom falls out of Europe next year and the Eurozone has a horrible recession where output shrinks by 5% in real terms. That would subtract .75% from world expansion. The globe would still grow, but by 2%+ instead of 3%.
That’s it for today. More on this topic tomorrow.