Taking Stock of Europe
Concerns out of Europe sent U.S. stocks in a decline Thursday reminiscent of declines during the 2008-2009 global financial crisis. The slide from recent peaks has left investors wondering if this correction will develop into another bear market. The correction experienced is not necessarily a surprise given the significant recovery the market has produced since March of 2009. What is surprising is the reason for the correction: Greece – specifically Greece’s questionable ability to service its debt and the implications a default might have on Greece’s neighbors in Spain, Portugal, Italy and Ireland.
First, it’s worth noting that while the stock allocation of Truepoint-managed portfolios includes approximately a one-third allocation to foreign markets, the widely diversified holdings do not represent excessive exposure to Greece or any other European country with a tenuous fiscal outlook. This is reflected in the fact that Greece is a minor contributor to the global marketplace, representing only about 2% of the European Union’s Gross Domestic Product (GDP).
However, in a globally interconnected economy, a fiscal crisis in one country can impact many countries. Since Greek debt is held throughout the world, a Greek default could reverberate widely. As a result, there is legitimate concern for the potential domino default effect throughout Europe and elsewhere. Particularly because some of the countries potentially impacted are already battling fiscal issues of their own (though of a much smaller scale than that faced by Greece).
There has been a concerted international commitment to keep this crisis from spreading. On May 10th, Europe’s finance ministers announced a €750 billion ($940 billion) rescue package which was initially positively received by investors throughout the world. While the rescue package does not solve the fiscal problems in Greece, it does buy the government time to get its fiscal house in order. Unfortunately, the volatility of global markets over the last 10 days reflects investor concern as to whether Greece will make the difficult policy decisions necessary to shore up its balance sheet and give investors confidence that Greek debt will be repaid in full.
Painful change rarely occurs in the absence of crisis. Examples of such change could be civil servants throughout Europe pushing retirement off to the age of 65 instead of 55 or 60; or, in Greece, requiring citizens to pay all of their taxes instead of just some of their taxes. While change in this region may be difficult, don’t underestimate the potential for change to occur. Just last week, Spain’s Socialist Prime Minister, Jose Luis Rodriguez Zapatero, abandoned his vision of an expanding welfare state and announced spending cuts of €15 billion ($19 billion) over two years. The cuts will impact civil service pay, social programs and pensions. While this move represents a drop in the bucket, it is nonetheless a step in the right direction. Ultimately, the only way for countries both large and small to work their way out of a high debt-to-GDP crisis is through a combination of fiscal austerity and economic growth. Finding the balance between these two imperatives will be challenging but attainable. One such example of success is the United States after World War II.
Dissimilar to the global financial crisis of recent years, the European debt crisis is taking place during a time when the global economy is expanding as opposed to contracting. And unlike two years ago, governments throughout the world are better equipped to deal with financial crises today. However, no one knows for certain how and when this crisis will end or whether we will see further signs of global contagion. What we do know is, as with past market crises, the resulting volatility creates rebalancing opportunities for the long-term investor. We will continue to capitalize on this volatility by making incremental purchases of depressed asset classes in order to benefit from a future recovery. While the timing of such a recovery is never clear in foresight, disciplined investors can remain confident in their eventual participation.