Don’t Forget the Eurozone Mess

Bellwether parcel delivery company FedEx Corporation (NYSE/FDX) recently announced it was cutting jobs due to the slowing demand from Europe and Asia. However, the stalling from Europe is not confined to a single sector, but spreads out across the board, and this poses stock market risk. Economies around the world, from the U.S. to Europe and China, are impacted.

This dire situation is not going away soon, and in my view, it will take years—perhaps decades in the case of Greece—to resolve, adding to the stock market risk. The irony is that traders appear to be underestimating the potential impact from Europe and the stock market risk.

In reality, the market is betting on a resolution and calm returning to the eurozone. Spain will likely require a full bailout when it makes a formal request. European Central Bank (ECB) president Mario Draghi said the central bank would help Spain once it formally requests a bailout. Spain has already received about $130 billion to avert a financial crisis in its fragile banking system. In my opinion, the ECB wants to see Spain put together a tough austerity program in exchange for a bailout, but Spain is trying to avoid this.

The yield on the 10-year Spanish bond fell to a seven-week low of 6.2% on Monday after trading over the critical 7.0% level. Optimism towards a Spanish bailout is helping to support and is reduce the high stock market risk for traders.

The yield had been on a steady upside move since trading around 5.0% in late February. The reality is that the high yields are unsustainable and add to the stock market risk.

Spain is broke, so high financing costs are not desirable, as they would increase stock market risk. Recall when Greece’s 10-year bond yield surpassed 7.0% and eventually surged to over 90.0% on fears of a default before the International Monetary Fund (IMF), the ECB, and the European Commission anted up $146 billion in cash in the first loan tranche. Unfortunately, as we all know, it was not enough; Greece subsequently asked for more funds to pay just the debt payments on its initial loan.

There is heavy debate, with Greece’s desire for a softening of the austerity measures meeting tough opposition from key lender Germany, which is facing its own growth issues. Greek Prime Minister Antonis Samaras is currently meeting with eurozone leaders and asking for a two-year extension to the deadline proposed for its austerity and budgetary plans.

In my view, the deal with Greece and upcoming deals to save Spain and the euro represent only a bandage solution to a much more significant situation. The mounting debt on the balance sheet of the eurozone countries is crippling, impacting economic growth, thereby increasing stock market risk. With this level of debt, a country is handicapped in its spending efforts to pump up its economy. Unfortunately, this vicious cycle is realistic, and this will make it very difficult for the eurozone going forward, adding to the stock market risk.

The 27-country European Union and 17-country eurozone are facing economic contraction, as these economies contracted by 0.2% in the second quarter following a flat first quarter, according to Eurostat. Another down quarter and the region will technically be in a recession. Already, six of the eurozone countries are grappling with a recession. Italy just reported its fourth straight quarter of contraction. And Capital Economics said France and Germany will face another recession in 2013. The news is not what you want to hear, given the existing mess, and increases the stock market risk, in my view.

The grave situation in Europe will continue to pose global issues and raise stock market risk. The eurozone risk remains a significant variable that will take time to resolve.

The post Don’t Forget the Eurozone Mess appeared first on Investment Contrarians.

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