How big a threat is Europe to the market?

Founder and Publisher of the Switzer Report
Print This Post A A A

For those who haven’t sold their stocks in May and run away – which is always a lot easier to say than do – you can’t help feeling that a lot could go wrong between now and October, when the Yanks usually get ready for a Santa Claus rally.

The challenges

In fact, at the end of this year there will be a couple of US challenges that could actually rob us of the usual Christmas gift from Wall Street and the New York Stock Exchange.

First, there is a US election result in November, which, if Barack Obama gets up, could spook the US stock market. And then there are a number of stimulus programs that will end, which could unsettle the markets, especially if the USA is not growing strongly at the time.

Jeff Schwarte, a portfolio manager at Principal Global Investors, thinks US market fundamentals are pretty strong, but Europe is the negative force.

That said, he told CNBC that the “biggest challenge” for Wall Street is the “fiscal cliff at the end of the year,” when these stimulus programs and tax cuts are set to finish.

Of course, a new US president and promised new programs could change investors’ attitudes, but we still need to cope with Europe’s anti-austerity movements, left-wing governments, likely higher bond yields, the threats to financial stability for the banking system and let’s throw in China’s economic landing, which most expect will be soft but could end up being harder than tipped.

Market resilience

Over the weekend, a US$2 billion loss from JPMorgan on a failed hedging strategy did not rattle Wall Street, which is a good omen, at least in the short-run. The Dow only lost 34.44 points or 0.27% to finish at 12,820.60. The S&P 500 lost 4.6 points or 0.34% to close the day at 1,353.39. For the year, the Dow is up 4.94%, the S&P 500 7.62% and the Nasdaq 12.62% and so they are all losing altitude, but it is still a nice start to the year on a historical basis.

US company profit news has been good with 66% of the 450 companies in the S&P 500 that have reported beating expectations.

Meanwhile here in Australia, our S&P/ASX 200 index is up 5.6%, which poses the question, is the catch up on Wall Street starting to happen?

And as the slide slips slowly in the US stock market, the VIX, or fear index, is rising and is close to 20. This is still an OK reading, but it was getting down to 15 or so before May.

A mega worry

While I will watch the swag of economic data coming out of the US this week, Europe is my main mega-worry issue.

The Financial Times says rumours are rife that hedge fund managers are talking about a euro pegged to the US dollar at parity! That is crap, excuse my French. Certainly, the more left Europe becomes, the lower the euro could go and the higher sovereign bond yields could go as well.

A lower euro would hurt the Yanks, who have done well out of a low dollar, and that means the world’s largest economy could cop a double whammy of less export income and a higher dollar against the euro.

China’s role

The Financial Times says 18% of China’s exports go to Europe and exports to the eurozone fell 2.4% in April, which makes sense as many countries on that continent are either already in or heading into recession.

Another intriguing trend was noted by London-based Stephen Jen, of hedge fund SLJ Macro Partners, who told the Financial Times he thinks China will shift from investment-led growth to a more consumption driven model.

Impact on stocks

This will hit prices of the commodities we export to China, hurt share prices of the likes of BHP (BHP) and Rio Tinto (RIO), lower our dollar and should help consumer discretionary stocks, import-competing companies and exporters who need a more competitive currency.

All of this is the strongest case ever for having a portfolio of shares with a good exposure to a number of different sectors.

On the flipside, there are those who believe the resources story will power on and I noted Clifford Bennett from the White Crane Group thinks the currency could be at 113 US cents by year’s end, rising to 120 and 128 US cents after that! But Clifford can be right, he can be wrong, and he can be a little too excitably crazy at times!

Note, he was the most bullish commentator last year when it came to stocks around September to October and he got that right. However, I think his currency call for this year is too big – way too big!

Europe worries me in the short-term, but I ironically think the anti-austerity movement might create more growth in the medium-term and that will be a plus for stocks. However, there’s going to be a few dramas this year.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.

Also in the Switzer Super Report:

Also from this edition