3 Reasons to Care About the European Bailout

With little more than a glance at the global markets on Monday, it was obvious that the announcement from the European Union was huge.

Germany's DAX rose by 5.3%, the U.K.'s FTSE 100 climbed by 5.2%, and France's CAC 40 jumped by almost 10%. Individual stocks in some of the most affected areas reacted even more sharply: National Bank of Greece (NYSE: NBG  ) tacked on 15%, while Spain's Banco Santander (NYSE: STD  ) soared by 23%. Even the U.S. markets surged, with the S&P 500 up 4.4% and the Nasdaq higher by 4.8%.

Despite the show of fireworks on the global equity markets, many U.S. investors would probably like to put the whole EU situation in a box labeled "things happening over there" and safely slide it under the bed next to the Ab Roller. Bad idea.

Although there may be some overseas developments that U.S.-focused investors could safely tune out, this isn't one of them, and here are three key reasons why.

1. It is huge
Remember the U.S. TARP program that caused such a hullaballoo? That was announced as a $700 billion backstop. The package that the EU announced is darn close to $1 trillion. That's 12 zeros, in case you're wondering.

The size was a necessity because of both the magnitude of the problem that the EU is facing, and the dilly-dallying that the leaders did while responding to the situation in Greece.

But even if the size was necessary, it's bound to cause major problems. For instance, Germany was on the fence about opening its pockets to struggling EU countries in the first place, and as major global exporter, it's a country that would actually benefit from a weaker euro. And while the situation in Germany may look rock solid compared to that of Greece, the German economy contracted by 5% last year, and recent local elections suggest that the German people would prefer that the government keep its focus on Deutschland. In other words, it's hard to count Germany as a solid partner of the over-indebted countries.

Meanwhile, as part of the massive bailout effort, the European Central Bank has pledged to start buying up sovereign debt to help ease the debt crisis. If this sounds familiar to Americans, it's because it is -- the Federal Reserve did something very similar during our meltdown. But since the ECB is supposed to be independent, the fact that it's participating in this rescue orgy could raise questions.

All of this is to say that the size and scope of this bailout makes it a major make-or-break moment for the EU's very existence. Handled well, this could bring the group to a new level of cohesion that most observers didn't believe the union had before now. If it gets botched, on the other hand, there seems to be a significant risk that the European Union could end up an uncomfortable memory.

2. It may not work
Twelve zeros or not, there seems good reason to believe that the bailout won't work.

The rioting in Greece suggests that the folks in that country are none too happy about the austerity measures that have been foisted on them to get the country's budget back in line. And considering the state of the country's finances, it seems like even more draconian measures may be needed.

Although Greece has been the focus, the issues with other EU countries are nothing to sneeze at. Spain, for instance, had a budget deficit last year of 11.2% of GDP, and that's with more than 18% unemployment. Meanwhile, on a percentage-of-GDP basis, Italy has a higher debt load than Greece along with a 5.3% budget deficit.

For this $1 trillion show of force to not end up signifying nothing, the countries that are doing the financial floundering need to make significant budgetary changes. And although this would be a difficult task for anyone, it happens to fall to politicians, who may balk at the suicide mission that's in front of them.

3. Surprise! You have European exposure
Just because you don't have National Bank of Greece or Banco Santander in your portfolio, that doesn't give you license to get complacent. Many U.S.-based companies with global businesses count on Europe for a significant portion of their sales.

Company

Products

European Sales (% of Total)

McDonald's (NYSE: MCD  )

Fast food

41%

Johnson & Johnson (NYSE: JNJ  )

Health care products

26%

General Electric (NYSE: GE  )

Industrial goods

24%

United Technologies (NYSE: UTX  )

Elevators, escalators, HVAC, security, and aerospace

23%

Intel (Nasdaq: INTC  )

Semiconductors

15%

Source: Capital IQ, a division of Standard & Poor's.

Turmoil in Europe, whether it happens now, or is postponed thanks to the bailout, would probably hit these companies where it hurts.

Of course, not all of the companies would see a similar impact. GE, United Technologies, and Intel, for instance, are all more reliant on positive economic momentum to drive sales, since they count on business and capital spending. McDonald's and J&J, on the other hand, may hold up better because demand for their products is a little more inelastic.

However, what would affect all of these companies is a weaker euro. If the euro weakens -- which, because of the size of the bailout, may happen whether or not the bailout works -- all of these companies will suddenly see the money they earn in Europe translate into fewer dollars when they bring the money back home.

Know thy portfolio, Fool
The key to navigating the situation in Europe isn't to panic and avoid anything that has European exposure. Instead, it's knowing where you're exposed and how downside scenarios in Europe would impact those investments.

At the same time, with skepticism swirling around European investments, there may be opportunities hiding out. As my fellow Fool Alex Dumortier recently pointed out, Telefonica, which has significant Latin American exposure, and Royal Dutch Shell are European companies that could be prime for the picking.

Europe may not be the preferred international investment destination right now, but that doesn't mean you shouldn't venture outside America.

Intel is a Motley Fool Inside Value pick. Johnson & Johnson is a Motley Fool Income Investor pick. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer owns shares of Johnson & Johnson, McDonald's, and Intel, but of no other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow him on Twitter at @KoppTheFool, or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (14) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 12, 2010, at 3:10 PM, Fliujniligui wrote:

    "Turmoil in Europe, whether it happens now, or is postponed thanks to the bailout, would probably hit these companies where it hurts."

    I think people are too fast at guessing that the mess is unavoidable. It seems that buying time at a good price and using it to do good stuff to fix problems can give results. This possibility is fast ruled out by the market. I am long NBG and STD big time and will buy on dips.

  • Report this Comment On May 12, 2010, at 6:19 PM, buntyp wrote:

    What I would like to get a re-fresher course on, is what are the 'Terms & Conditions' for member Countries in the E.U., that they are supposed to abide by in order for them to have been admitted in the first place.

    If my memory serves me right, it was some time before Greece, Spain, & Portugal, became a part of the current E.U. make-up.

    I see Greece being 'ditched', eventually by the other members of the E.U., if the kind of skylarking by the whole people of that Country continues.

    I seem to recall that there were serious reservations about allowing Greece into the Membership Club, just prior to them being admitted.

    This 'Bailout' to me seems as a real last ditch stand by the other Member Countries, mainly to try & save the Euro currency.

    If Greece continues to play the fool, & a couple of the 'Member Countries', start to get seriously nervous, it could very well happen that they'll so affect the other 'Member Countries', that a decision could be taken to cut their 'Losses' & jettison Greece.

    Maybe the average 'Greek Citizen' won't give a hoot if their Currency, which they would have to revert to, was massively De-valued, once the Govt., without the scrutiny of the other E.U. Countries, would be able to print as much 'Funny Money' as possible.

    That is the sort of scenario that 'Socialist Historians' refer to in hindsight as 'Un-intended Consequences'.

    'Socialist Dogma' usually ends when everything is collapsing, & people start looking around for 'A Real Dictator', because all Idealogies seem at that point to have been only 'Sold to them' by the 'Big-Shots' simply to have served to Distract the Populace.

    The 'Chinese' for e.g., are looking very askance at the U.S., & what seems to be an un-sustainable 'Economic Model'.

    What they (the Chinese) will eventually discover, is that there is no 'Economic Model', that can be described as such, existing in the Govt. side of the U.S.

    That perhaps should be of a more immediate concern to Folk who read these Columns.

  • Report this Comment On May 12, 2010, at 7:14 PM, TMFKopp wrote:

    @buntyp

    Interesting thoughts.

    A primary reason that the Eurozone won't be so quick to ditch Greece, though, is the fact that many of the other Eurozone countries aren't in such good shape either. Should Greece be cut loose, it would be open season on Spain, Portugal, Italy, and Ireland, not to mention the euro itself.

    IMHO, it's an all-or-nothing fight at this point. Either the entire Eurozone gets together to defend the currency or they let the whole thing unravel.

    Matt

  • Report this Comment On May 12, 2010, at 7:14 PM, esuresh12 wrote:

    First we have to look at our own back yard instead of looking at somebody else's. When we talk about the debt as percentage of GDP US debt is almost 80%. Compare this with Greece's debt to be around 11% of GDP.

  • Report this Comment On May 12, 2010, at 8:17 PM, bhogwild wrote:

    The debt numbers are confusing sometimes. I think the 11% number for Greece refers to the percent of their annual budget deficit relative to GDP. The 80% number for US debt refers to the total debt relative to GDP. One is an annual and the other is a total. I this right?

  • Report this Comment On May 12, 2010, at 8:27 PM, TMFAleph1 wrote:

    bhogwild,

    I think esuresh12 may have forgotten a digit in the figure he gave for the Greece public debt/ GDP; either that, or you are absolutely right.

    Greece's budget deficit/ GDP ratio was a stunning 13.6% in 2009.

    Alex Dumortier

  • Report this Comment On May 12, 2010, at 9:57 PM, buntyp wrote:

    TMFKopp,

    Matt,

    Thanks for your response & thoughts on this Euro business.

    Your last paragraph is perhaps the very moot concern, & is what eventually may have influenced the Decision to consider such a substantial, but necessary kind of 'Bail-out' quantity of Money & commitment.

    The four Countries you list as kind of 'Shaky', are among all the latest entrants to E.U.

    I seem to recall there being a lot of agonizing among the, what I call, 'Charter Members', when these Countries applied for Membership in the Union.

    Perhaps what disturbs me is the reaction of the Folk in Greece, which we see now so often on the T.V.

    I recall also a time when I began to believe that 'Modern Greece' was like becoming the anthesis of 'Plato's Republic.

    There was at that time, in Greece, such a voluble cry for outright 'Communism' by a seeming majority of ordinary Folk.

    This is a time to watch that Euro scene very carefully.

    Sarkozy, in France, shortly before, & shortly after, he came to power, was bemoaning the whole 35 hour work week concept, that the Govt. workers had come to accept as the 'Norm'.

    I don't recall that he ever got too far with that subject.

    Like the U.S., there has been a slow down in Europe, in the 'Birth Rate' for a generation, & therefore less young people to continue paying for all these entitlement programs.

    There is a large & growing Immigrant base, that have very high un-employment numbers, but all as Naturalized Citizens, have all their 'Expectations'.

    Nuff Said!

  • Report this Comment On May 13, 2010, at 3:44 AM, investorms23 wrote:

    bogwild and TMF, Sorry to confuse with two different things, here are the actual numbers,

    US total debt : 98.1%

    Greece total debt 117.5%

    But whatever be the case, the US debt is substantially high to worry about and if not controlled is going in the direction of Greece.

    Coming back to the original issue, yes Matt your analysis do makes sense. This was a similar situation in 2007 but it was internal problems in U.S. Now it is the whole of EU. I will use this information to adjust my stock portfolio with some downside protection.

  • Report this Comment On May 13, 2010, at 4:06 AM, automaticaev wrote:

    what?? Buying euro banks and us banks and all banks and shorting the "garbage banks" (what a bank is any time its going down) will make you a lot of money. Thats all you should do its the best strat.

  • Report this Comment On May 13, 2010, at 4:11 AM, automaticaev wrote:

    I told you guys before BUY BANKS thats all you had to do.... Thats what you should do if you want the money is buy the banks..... Its so simple no one can fail.....

  • Report this Comment On May 13, 2010, at 10:03 AM, dothemathCT wrote:

    In "The Ascent of Money" Niall Ferguson gives a concise overview of how financial markets work and also, fail.

    Unfettered spending leads to credit downgrades leads to defaults leads to ruin. This pattern has been repeated many times throughout 400 years of financial history.

    If you believe this time it is different, for whatever reason you want to rationalize so, I have a frictionless economy internet stock for you. You can fund your purchase with an interest only loan.

  • Report this Comment On May 13, 2010, at 11:34 AM, jrj90620 wrote:

    Reality eventually catches up with all countries using dishonest fiat currencies.Fiat currency countries deserve this. Stealing is wrong.Only a move to real money currencies can work long term.

  • Report this Comment On May 13, 2010, at 6:24 PM, TMFKopp wrote:

    @jrj90620

    Can you provide an example / model of a country that is using "real money currencies" in the modern era?

    Matt

  • Report this Comment On May 13, 2010, at 7:14 PM, EuroBob7 wrote:

    Hmmm - Greece will be 'cast adrift' probably in 2011 if the austerity measures do not work or are not implemented. Spain (the elephant in the room) will not be allowed to fall - it is too big. For you guys investing in Europe stocks remember the exchange rate is the other variable you have to consider. However in the medium term it should fall against the dollar unless the Fed and/or the US govt do something foolish. A falling euro is good for Europe it has been overvalued for some time.

Add your comment.

DocumentId: 1181316, ~/Articles/ArticleHandler.aspx, 7/24/2014 7:09:07 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement