Fund managers: Bleak outlook in European crisis

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BOSTON (AP) — The American Revolution was about breaking with Great Britain, and asserting independence from European powers.

Yet it might seem a battle is still being fought, as Wall Street reels from America’s persistent ties. News about Europe’s debt crisis has been the key factor driving U.S. stock prices in a volatile first half of September. Fears about a potential government default in Greece are overshadowing worries about the slowdown in the U.S. economic recovery.

How can a European nation with a population the size of Ohio’s and an economy the size of Maryland’s have such a big impact on U.S. stocks, and the investment portfolio you’re counting on for retirement?

Mutual fund managers who invest abroad say the key reason is that Greece’s struggle isn’t the only crisis the European Union faces. It’s merely the most imminent one, and a default could ripple throughout European banks. Spain, Portugal, Italy and Ireland also are in terrible fiscal shape. Whether European leaders can find a way out of these crises will likely determine whether the continent can avoid a potentially long struggle.

“With all this uncertainty, it looks like Europe is going straight back into recession,” says Chuck de Lardemelle, a native of France who co-manages a pair of U.S.-based stock-and-bond funds, IVA Global (IVIOX) and IVA International (IVWAX). “This will have a huge impact on the U.S. economy.”

Below are four things that investors need to know as Europe tries to prevent financial contagion, across the continent, as well as in the U.S. The information reflects the thinking of de Lardemelle and Sarah Ketterer, co-manager of the $1.4 billion Causeway International Value Fund (CIVVX). Both are veteran international investors with strong long-term records:

1. Economies are inextricably linked:

In the global economy, ties between the U.S. and Europe are especially close. That explains why stock markets on both sides of the Atlantic have been so in sync lately. Consider that the total U.S. investment in Europe is three times higher than it is in all of Asia, according to EU data; and some 15 million jobs are linked to the transatlantic economy.

Europe accounts for 22 percent of all U.S. exports. Exports have recently been a key driver of U.S. economic growth, although that growth has been anemic. This positive factor is now at risk if the value of the euro continues to slide against the dollar, as it has during the debt crisis. A stronger dollar makes U.S.-made goods and services costlier to foreign buyers, so the 17 nations using the euro buy less. And budget cuts by European nations further crimp the ability of Europeans to afford U.S. products.

2. Investments are connected:

Investors in many U.S. money-market mutual funds have a huge stake in Europe. At the end of June, so-called prime money funds that invest in corporate rather than government bonds had nearly half of their holdings in commercial paper and certificates of deposit issued by European banks, according to Fitch Ratings.

De Lardemelle worries that any worsening of the debt crisis could freeze the European market for commercial paper — a form of short-term debt that companies rely on to meet short-term needs such as payroll and supplies. Such a freeze also could affect U.S. investors in prime money funds, which hold more than $500 billion of the nearly $2.6 trillion in money funds. A commercial paper freeze helped trigger the 2008 financial crisis in the U.S., and any further trouble in that segment could ripple throughout economies on both sides of the Atlantic, de Lardemelle says.

3. Europe and U.S. both face debt challenges:

The U.S. and many European countries have aging populations, which imposes a growing burden on government entitlement programs. In the wake of the 2008 crisis, governments and consumers continue to pare back debt. But it’s clear we’re still early in a process that will constrain economic growth, and test political leaders here and in Europe. “It will continue to be a painful and long process, but leaders so far have not been willing to really get in front of the problem,” de Lardemelle says.

4. Nations face politically different paths:

Although Europe and the U.S. share similar debt struggles, there are crucial differences. Following 2008, Europe was slower than the U.S. to try to ensure that banks have a financial cushion to survive another crisis, as a result of tighter capital requirements. And while lawmakers in Washington haven’t been striking many compromises lately, Congress and President Obama are in a better position to reach a consensus on debt issues than the 27 EU member nations.

EU leaders have approved a series of short-term individual country bailouts that are proving inadequate. De Lardemelle and Ketterer blame conflicting agendas among EU members and its awkward governance structure. That’s why Greece remains headline news more than a year and a half after its troubles began rippling into U.S. financial markets. If there’s a lack of political will in Europe to tackle debt problems in a comprehensive way, the EU could break up, or use of the euro as a common currency could be scaled back.

Whatever pans out in Europe, it will have an impact here. “I don’t see a path to resolution in Europe yet, and we’ll continue to see anxiety in U.S. markets,” de Lardemelle says “It’s an interconnected world.”

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