The European Financial Crisis is far from over and continues to weigh on the minds of investors. Markets received a reprieve from the European debt crisis early this year as Greece submitted to an "orderly" default. Regardless, Europe's issues are numerous. Here, we help translate four reasons the European debt crisis will continue to percolate in the coming months and even years:
1. Debt Rollovers: Those who have been following the European situation recognize that the fundamental problem, which seems impossible to solve is how to finance operations, or better yet, pay-off debt. With recessions imperiling debt hot spots, the opportunities to spruce up their balance sheet seem fleeting. As debt comes due, it must be refinanced.
Interested observers will note that the refinance and debt rollover calendar of countries like Spain and Italy will correlate highly to times of higher perceived threats to economic stability in the Eurozone. The success of each bond auction is closely watched for signs of deterioration or renewed crisis.
2012: A Big Year for EU Debt Rollovers
2. Austerity & Its Side Effects: The prescription for much of the Euro issues has been "spend less". Certainly spending money poorer countries do not have will not solve the problem today, but austerity (forced spending cuts) comes with its own side effects. As countries make significant cuts in spending, unemployment can increase and the wings of potential growth can be clipped. This becomes a circular process.
3. Credit Default Swaps: The advent of derivatives called "Credit Default Swaps" in the 1990s resulted in the "opportunity" for banks and investors to insure against risk of failing companies or countries. Today, European banks and, indeed, financial institutions around the world are riddled with CDS exposure to limping countries like Portugal and Spain and banks in these countries which hold much of the same troubled debt. These derivatives can have a multiplier effect in the world's financial system making a bad situation worse.
4. Politics: When the going gets tough, elected officials have a tough time holding office. We've already seen changes in government in Italy and Greece. France has replaced Sarkozy as president, making a clear statement about the demand for change there. It is equally as important to recognize the political dynamics in debt-ridden European countries like the PIIGS (Portugal Italy Ireland Greece Spain), but also to watch the currents in the healthy ballasts to the Eurozone such as Germany and France.
Market volatility throughout the world has been reduced in part by actions and statements from Angela Merkel and the ECB indicating strong commitment to continuing to address Eurozone issues. With potential change or weakening of political will comes uncertainty and this can damage potential for normalcy.
So what's an investor to do? We believe the EuroCrisis will continue to be a drag on world economic growth. That said, markets are often self-correcting systems. Overall economic concerns can lead to opportunities in stocks that become undervalued. As Europe limps, Asia and the US may pick up the slack and be the recipient of relative competitive advantages.
If you have a long-term time horizon, waiting for an "all-clear sign" or a sunny day is often a fool's errand. Consistent execution of a well-defined investment process coupled with a diversified portfolio is our EuroCrisis prescription. In plain English, you must weather the storm.
Diversification does not ensure profit or protect from loss in declining markets. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James. International investing involves additional risks such as currency fluctuations, differing financial and accounting standards, and possible political and economic instability.