Why Europe’s my biggest market concern right now

Founder and Publisher of the Switzer Report
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It sure was a bad week at the office for investors, but remember, we shouldn’t assess our investment outcomes on a weekly basis. If you’re a long-term investor, which most SMSF investors are, your focus shouldn’t be on BHP Billiton’s current price of $38.12, but what its price will be in two or three years time.

We’re living through troubled markets, but I know they’ll eventually sort themselves out and both economic and share price growth will pick up.

So why the sell-off?

First, the procrastination in Europe over whether the European Financial Stability Fund (EFSF) should support Italy and Spain caused a lot of concern. The EFSF was created to run Europe’s sovereign debt bail-outs and support the PIIGS – Portugal, Ireland, Italy, Greece and Spain. Europe’s actions sure have been confusing the markets. Last week when Italian and Spanish bonds were being trashed by the so-called bond vigilantes, the European Central Bank (ECB), a body that supports the EFSF, was buying Portuguese and Irish bonds!

Howard Archer, IHS Global Insight’s chief UK and Eurozone economist, says the current turmoil in European and global markets is primarily the consequence of mounting fears of a major global economic slowdown and the worsening Euro zone sovereign debt crisis.

At the same time, the performance of US politicians over the debt ceiling and deficit package, combined with a slowing US economy, have created a perfect storm. This let loose on Friday with a 4.6% sell-off of the S&P/ASX 200. Monday saw the index up 1.65% on expectations that a debt agreement would be passed, but then Tuesday brought a 1.43% drop, Wednesday a 2.27% tumble and Thursday a 1.3% decline.

This was an overreaction – big time!

To add more pressure to the pot, the dopes at Standard & Poor’s thought it was timely to downgrade the US’s credit rating to AA+, despite Fitch and Moody’s still maintaining the country’s AAA rating.

Ironically, the slowing US economy was slightly countered over the weekend with a better-than-expected jobs report. The US created 117,000 new jobs in July and unemployment fell to 9.1%. The news was OK – nothing flash – but it certainly leans against the doomsday merchants who want to run the ‘we-are-going-to-hell-in-a-hand-basket’ argument.

I suspect the markets will remain challenged early this week because of the S&P downgrade, but I believe actions will be taken to allay fears. European officials, especially at the ECB, have said they will start buying bonds to help Spain and Italy. And in the US, Federal Reserve boss Ben Bernanke is bound to say a few things that could suggest a third quantitative easing package could be on the cards to help the economy.

On the debt downgrade, CommSec’s chief economist Craig James says: “The implications are limited. While it is a history-making event, at the end of the day the major investors are unlikely to abandon US treasuries or the US dollar. Simply, the alternatives aren’t compelling. Would China switch from the most liquid bond market in the world to European or Japanese bonds?”

Looking ahead, I want to see the US economy pick up and I expect it to happen in the coming months. And the Europeans have to lift their game.

To understand Europe’s part in the sell-off, have a look at what the European Commission president José Manuel Barroso acknowledged on 3 August.

“There is a growing concern among investors about the systematic capacity of the euro area to respond to the evolving crisis,” he said.

This was the main reason why shares slumped last week and this is what has to be fixed this week. Believe it or not, the EU thought the ECB could run the sovereign debt management program on its own for a short time, but the reason why will astound you:

“The thinking was that the ECB would be able to deal with financial issues until politicians were back from their summer vacations and able to pass the necessary measures, but the ECB has kept the onus on stressed governments to take concrete steps before providing (bond-buying) support as it has done with Portugal and Ireland,” Howard Archer explained.

So the ECB was in charge while the politicians were on holidays, but the ECB didn’t want to do anything until the politicians passed tougher measures to sort out their debt problems. It’s the script for a B-grade foreign film – a farce of course!

Given the seriousness of the economic and stock market challenges, you would think holidays would be delayed until the EU’s financial foundations are shored up. The biggest problem with Europe is that it’s run by Europeans! Our wealth depends on the collective good sense of their decisions and that’s my biggest concern.

Also in the latest Switzer Super Report:

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