Monthly market commentary
June 2012 edition
For the last few weeks, all eyes have been on Europe. We’ve got our own challenges right here in the United States, but risks in Europe are more immediate, more acute. Over the weekend, Spain (the Euro area’s fourth largest economy) agreed to borrow $100 billion Euros on behalf its banks, several of which are reeling from real estate investment loans gone bad. Greece, a caricature of the profligate southern tier of countries, faces another election next week that could bring a leftist to power, leading the country to ignore earlier commitments for austerity measures and perhaps hastening its exit from the Eurozone.
By most measures, we are about two years into the European debt crisis, and still it appears the parties remain far apart with respect to developing long term solutions. Germany and its northern neighbors are loath to use their financial strength buttress the economies of more indebted countries unless they cede some of their budgetary and fiscal sovereignty. In the reverse, countries like Spain and France are critical of Germany’s calls for deep austerity when large swaths of their citizens are unemployed. In fits and starts, however, it does appear that the two sides are coming together out of necessity. Maybe the Greek elections on June 17 will be the catalyst to ignite more meaningful compromises.
Why does Europe matter to the average U.S. investor when this country is struggling to ignite economic growth fast enough to bring down the unemployment rate? For one, Europe is a significant trading partner (on par with Canada) with the U.S. It buys approximately 18 percent of U.S. exports and is the source of 17 percent1 of U.S. imports. If Europe buys less of our exports because their growth falters, U.S. growth follows suit. Furthermore, the U.S. and European banking systems are intertwined in many ways. As one example, money market funds and other investors are required to buy only the highest rated short term debt instruments. The list of European banks with eligible credit ratings has dwindled significantly over the past several months, complicating the already difficult task for U.S. money market managers. Sentiment also matters: if the Eurozone suffers an acute crisis, even if the direct effects are contained, negative sentiment is likely to weigh further on investment values across the globe.
Ten-year U.S. Treasury bond rates fell to a record low of 1.45 percent on June 1, as investors here and across the globe chose paltry rates of return in exchange for safe harbor from the European storm. While the rate has rebounded slightly over the last several days, it still remains well below the 2.05 percent it plumbed during the depths of the credit crisis late in 2008. Many have expected interest rates to move higher as bond investors demand compensation for increased risk the U.S. political system and on the expectation that the economy would heat up again. Neither appear to be on the near term horizon, though, as investors continue to prefer safety over return.
Stock market values have swooned in recent weeks too, but we suspect the causes are broader than the problems in Europe. While economic indicators continue to point toward recovery, their meandering path suggests we are in for an extended period of slow growth. Unemployment, while declining in recent months, has been above 8 percent for more than three years and home prices as measured by the S&P/Case Shiller Composite 20 Index appear to be probing a bottom after several years of declines.
Summing it up
Europe matters to U.S. investors. Whether direct through the effects of trade and financial flows or indirect through investor sentiment, the crisis in Europe is likely to be front and center over the next several months. The U.S. faces its own political and economic challenges too, with the presidential and congressional elections this fall and the pending expiration of tax rate cuts at the end of the year. These risks will likely to drive a continuation of the volatility we have seen for several years now, but their eventual resolution may also lay the groundwork for a better investment environment.
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Chad M. Horning, CFA, is chief investment officer for Everence Financial.
1 U.S. Census Burueau