Europe is being blamed again today for the volatility in the U.S. equity markets, but some market watchers are saying the knee-jerk reactions by investors are overdone.
“The market's reaction has been a bit extreme,” said Brian Gendreau, market strategist at Cetera Financial Group Inc.
With Greece and Italy now seen as the biggest losers in the European Union, Mr. Gendreau said the markets are already factoring in Greece's likely default on its sovereign debt.
“I think the very fact the people are talking about taking a haircut on Greek debt means Greece is probably not going to pay,” he said. “The only question remaining is whether it will be an orderly or a disorderly default.”
With Greek bonds paying yields in excess of 30% and the debt seen as radioactive, the markets have focused on Italian bonds yielding more than 7% and a 2.5% one-day drop by Italian equities.
“The [eurozone] still really needs a solution to the debt crisis, and we're still in the middle of this,” Mr. Gendreau added. “But right now, people are just afraid of Italian debt.”
Finger pointing
By midday Wednesday, U.S. stocks were trending lower, with a lot of fingers pointing toward Europe.
Both the S&P 500 and the Dow Jones Industrial Average were down almost 1% by 12:30 p.m. ET, and the Nasdaq Composite Index was down 1.5%.
Doug Cote, chief market strategist at ING Investment Management, described the recent efforts by the European Central Bank and members of the International Monetary Fund to try to fund some of the weaker European economies as stopgap measure.
“They are putting a fence around the problem, which means it won't go away, but it also won't escalate,” he said. “It's still like a zoo where the animals are all running wild inside the fence, but at least the wild animals are contained.”
Based on developments in Europe over the past few months, and despite all the fear surrounding the European Union, Mr. Cote is confident that calmer heads eventually will prevail.
“There is enormous incentive for the countries at risk to get in line [and support some kind of austerity requirements],” he said.
One of the more telling developments out of Europe that Mr. Cote said has not gotten enough attention is the transition of the governments of Greece, Italy and Spain.
“They all changed governments during three weeks in November,” he said. “And it was all done peacefully.”
Game changer
This is not to suggest that the problems facing the European Union are anything less than game changing.
The combined European economic region, at $12 trillion, represents the world's second-largest economy, behind the United States at $14.5 trillion.
“No economy the size of the European Union has ever been in this kind of trouble,” said George Feiger, chief executive at Contango Capital Advisors Inc.
“These people are screwed, but right now, they're dribbling just enough money into the system to keep it going,” he added.
Mr. Feiger's take is that there are three major problems now facing the European Union: The banking system is running out of money, the governments are swimming in debt, and there is a lopsided productivity imbalance with Germany on one side the rest of the eurozone on the other.
“Right now, the banks need the equivalent of [the Troubled Asset Relief Program], but they won't get it, and the European governments have to borrow money just to pay the interest on their debt,” he said.
In terms of the productivity imbalance, Mr. Feiger said it is the result of a structural design flaw in the 11-year existence of the euro as a single currency.
“In the old days, a country would just devalue its currency to ease the productivity imbalance,” he said.
Ultimately, it all points toward major change for the European Union along the lines of government austerity and budget deficit ceilings.
“Moving forward, Europe will be establishing broader powers for central banks, and it will be a painful [austerity] plan, but there is no alternative to that,” said Peter Tuz, president of Chase Investment Counsel.
“But at the end of the day, they are rational people and they will come up with a plan,” he added.
In the meantime, the consensus is that the rocky road ahead for Europe will continue to affect the U.S. economy and financial markets.
“The strength or weakness of the global markets matters a lot,” said Jim Russell, investment strategist from the
U.S. Bank's private-client reserve.
Mr. Russell pointed out that 45% of the revenue from S&P 500 companies comes from outside the United States, including 14% from Europe.
The impact of the European crisis on the U.S. markets can be measured by the volatility index, which has been hovering around 27 for the past four months, which compares with a 20-year historical average of 20.
Jay Wong, head of equity strategy at Payden & Rygel, said the increased market volatility is “all Europe.”
“The European crisis already has reached the U.S. in terms of volatility, and that volatility weighs down investor sentiment,” he said. “Right now, the uncertainty surrounding Europe is politically driven, and I don't think there's any resolution in the near term; this will take years to resolve.”
