After a short break, the eurozone has gone back to its job of spooking stock markets.
Yesterday, the FTSE 100 fell 4.5%. And the Euro Stoxx 50 index – made up of the continent’s top 50 shares – took another 5%-plus tumble. That wiped out much of the last few days’ rally. In fact, this blue chip index is now over 25% lower than it was six months ago.
Yet all the while we are being reassured by Europe’s politicians that the single currency crisis has been sorted. Clearly it hasn’t. Here’s what this means for investors.
Europe started the stock market rot yesterday
The eurozone crisis has rumbled on unresolved for so long, it’s getting like ‘groundhog day’.
The ongoing problem is too much debt. Too many of the countries that share the single currency have something else in common. They owe more money than the market believes they can repay in full. So the list of potential bail-out candidates keeps getting longer.
Greece, Ireland and Portugal have already effectively gone bust. They’ve needed ‘rescue packages’ to keep paying their bills. But these may not be big enough to do the trick. And fears have kept growing that Spain and Italy might be next to seek ‘assistance’.
Such jitters have driven up these countries’ borrowing costs, as heavy selling has driven down the value of, and lifted the yields on, their sovereign bonds.
So the European Central Bank (ECB) stepped in two weeks ago to buy some of the eurozone sovereign debt that no one else wanted. And for a few minutes, the €22 billion the ECB spent seemed to work.
Here’s the real problem
But the real concern is this: ECB bond buying doesn’t take away any of that debt. It just switches it from one pile to another. So German chancellor Angela Merkel and French president Nicolas Sarkozy met up on Tuesday, supposedly to hammer out a solution.
Did this little natter help? The markets didn’t think so. The two said they wanted to ‘strengthen’ the currency, which is rather obvious. And Mr Sarkozy rattled on about extra fiscal union, ie more EU-wide political control.
But they ruled out reinforcing the €440bn European Financial Stability Fund (ie the EU’s bail-out cash). And no plan was announced for the whole of Europe to raise money by issuing Eurobonds.
“Given the urgency of this situation”, says Charlie Parker on Citywire, “it’s staggering the two leaders gathered to propose a series of measures that are only tangentially relevant to the true crisis”.
To be fair, though, the rejection of the eurobond idea was no great surprise. As ex-ECB man Ostmar Issing said recently in the FT, it would just let the likes of Greece off the hook and dump the German taxpayer with the costs. And the underlying problem is that with that mountain of debt as a backdrop, there were no good choices available.
“The only thing we do know”, says Kathleen Brooks on Forex.com, “is that Sarkozy and Merkel aren’t willing to ditch the eurozone and let the peripheral nations drown just yet”.
And here’s why it’s getting worse
Indeed, maybe they don’t want to. But they may soon have little choice. To make matters worse, as we mentioned yesterday, Europe’s economic growth rate dropped to a miserly 0.2% in 2011’s second quarter. Even Germany, Europe’s largest economy that accounts for 27% of eurozone output, expanded by just 0.1% compared with 1.3% growth in the year’s first three months.
Why does this matter? If Germany isn’t doing the business, it won’t be generating the level of tax revenues that were expected. That means the politicians and central bankers will have even less cash available to bail out the weaker eurozone members. In other words, the EU could run out of money even faster than any politician ever expected. So the chances of several eurozone countries being forced to default are rising all the time.
Of course, there’s always the option of printing more money, US and UK-style. But as we’ve seen in both countries, that doesn’t work either. What’s more, Germany probably wouldn’t agree to it anyway.
To recap, as John Stepek said last month, the likely bottom line is that “the eurozone crisis will end in panic”.
We certainly saw signs of that yesterday. And the first sector in the firing line will be banks around the world that hold eurozone sovereign debt. As there could be massive losses here, it’s no wonder bank shares tanked. French giant Société Générale, for example, fell 12% on the day and has nearly halved in value within a month.
Add some nasty economic news from the States (we’ll look at this on Monday) and it soon became a day to forget for most investors.
So what should you do now?
OK, in Europe, investors have known about the worsening situation for months. But this sort of ‘suspended disbelief’ can unravel very fast when confidence finally vanishes. As we’ve said before, it’s the domino effect in action.
While it’s important not to panic, forecasting the next move in markets is well nigh impossible. So you need a plan.
We’ve been warning about the dangers of cyclical shares for ages, so your portfolio should already be in ‘defensive’ mode. Sure, the stocks you hold can still fall. But blue-chip defensive high-yielders won’t go bust in a recession, and meanwhile will pay you a decent income.
It’s a good idea to start to build a watch list of stocks you’d like to buy, when the real panic starts.
And in this week’s MoneyWeek magazine roundtable, out today, our team of experts give their views on some of the stocks that should be firmly in your sights.
Category: Economics