Has Europe Killed the Recovery?

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Just as the global economic data was starting to take a turn for the positive, Greece had to go and throw cold water on the party. Despite the European Union and the International Monetary Fund announcing a $1 trillion (750 billion euro) support package for European nations struggling with crushing levels of debt, foreign markets have been spooked by the looming specter of default. This lingering fear and uncertainty has sent the MSCI EAFE Index, a measure of foreign developed markets, down nearly 10% year-to-date.  And a great number of fund managers are downgrading their expectations of growth as a result.

Lowered expectations
The latest Bank of America Merrill Lynch fund manager survey revealed that only a net 42% of managers expect the global economy will strengthen over the coming 12 months, down dramatically from a net 61% that thought so in April. These beliefs played out in practice, as the percentage of surveyed managers overweight in equities fell from 52% in April to just 30% in May. Conversely, the percentage that was underweight to bonds fell from 48% to 29% as fund managers sought safety in fixed income.

So are these investment gurus on to something or are they just running scared? Well, I wouldn’t go so far as to declare an end to the global recovery, but the truth is that the situation in Greece and the potential for similar financial crises in many other European nations are going to weigh on the continent for some time to come. There’s little doubt that the bailout will stifle growth across Europe, even in relatively healthy economies such as Germany. Austerity measures implemented in Greece and other debt-riddled nations will act as a further drag on euro zone growth. All told, Europe is likely in for a decent stretch of subpar growth and middling stock market returns.

Expand your horizons
That means that investors who were banking on European stocks to lead their portfolio into the next decade may have to do some shuffling. With the crisis in Europe, many investors have remembered the world’s second largest economy, Japan. While hot growth prospects aren’t exactly bursting at the seams in this corner of the globe, this island nation is home to several stable blue-chip names. Canon (NYSE: CAJ  ) and Panasonic (NYSE: PC  ) , for instance, have a worldwide presence and meaningful market share in their industries, and unlike many other stocks, they haven't seen their share prices inflated by the rally.

Of course, you can’t talk about global investing without mentioning emerging markets. These high-octane countries come with higher amounts of risk, but also greater long-term rewards, if you can stomach the ups and downs in the meantime. To play emerging markets right, I’d recommend taking a broad-based approach, investing in multiple countries and regions. Two of the best exchange-traded funds for this purpose include Vanguard Emerging Market Stock ETF (NYSE: VWO  ) and the SPDR S&P Emerging Markets ETF (NYSE: GMM  ) . Both provide wide market coverage at a very reasonable price.

And lastly, investors shouldn’t forget about the opportunities right at their doorstep. As Europe struggles to regain its footing, the U.S. market may begin to look more and more attractive by comparison. We shouldn’t make light of the fact that we are dealing with our own hefty debt loads and could face similar problems down the road. However, right now, our economics look much more solid, meaning that domestic stock markets returns could be one of the best things going in the near future. If you’re a fan of turnaround plays, two names to consider here are Southwest Airlines (NYSE: LUV  ) and Sears Holdings (Nasdaq: SHLD  ) . Both companies face significant structural hurdles in their industry, but Southwest has managed to remain profitable over its 37-year history. And while the consensus on Sears is pretty widely negative, superstar manager Bruce Berkowitz of Fairholme (FAIRX) fame has recently been bulking up his holdings in the stock. Maybe he knows something that the rest of the investing community doesn’t.

Still kicking
Despite the current risks, investors would be foolish to abandon Europe entirely. While the continent’s near-term prospects are much more uncertain than they were just a few months ago, you should still keep a foot in the European market. I wouldn’t go so far as to say that the recent market drop has created a whole bunch of screaming bargains, but a stock like Total (NYSE: TOT  ) is still an attractive buy. The stock trades at a reasonable P/E, has a solid dividend yield, and boasts low levels of debt. Don’t run screaming from Europe, but cutting back on overall exposure if you can probably isn’t the worst idea right now.

In the end, while Europe’s problems will likely take a hefty bite out of global GDP in the coming quarters, it shouldn’t derail the recovery process entirely. It will prolong the nascent recovery phase while likely adding a hefty dose of volatility to short-term market returns. There will be more risk in the market and in the global economy in the near future, but by keeping a long-term focus and making some subtle portfolio shifts, investors can ride out the uncertainty and still come out ahead.

For more insider investing and personal financial planning tips, check out the Fool's Rule Your Retirement service, which provides top-notch retirement and mutual fund advice. You can start your free 30-day trial today.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. Amanda owns shares of Fairholme. Southwest Airlines is a Motley Fool Stock Advisor selection. Total SA is a Motley Fool Income Investor recommendation. The Fool owns shares of Vanguard Emerging Markets Stock ETF. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (12)

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  • Report this Comment On May 18, 2010, at 6:23 PM, 51dochudson wrote:

    This is a totally predictable outcome. Since there is no such entity as 'Europe', the EU will not survive prolonged tough economic times. Yes, there may be individual stocks that remain attractive; but be wary if "Sovereign Debt" of France in particular is downgraded. The door is already crowded with "Europeans" bailing on their euros for gold and silver. Now the real question is: Can we determine if the massive short positions in gold and silver are a reality or only a 'Paper' transaction issue.

    Doc Hudson

  • Report this Comment On May 19, 2010, at 5:45 AM, EuroBob7 wrote:

    Maybe...but the drop in euro v the dollar will help the Europe economies recover as their exports become cheaper, vacations for folk outside the euro become cheaper (and the fall in euro drags down sterling also). Also for dollar investors euro stocks become more attractive and conversely the US companies with Europe exposure (IBM, Coca Cola etc) will see their dollar quarterly earnings reduced if the rate stays at current levels.

  • Report this Comment On May 19, 2010, at 9:43 AM, MKArch wrote:

    When the rest of the world was gloating about the U.S. recession in the early days and buzzing about the new paradigm of the world being decoupled from the U.S. economy I thought they had it bassackwards, the U.S. is still the engine of growth for the rest of the world. IMHO we are seeing that play out with the rest of the world slowing down without excessive U.S. consumption but the U.S. recovering nicely.

    China's official growth numbers look impressive but many have pointed to unprecedented stimulus, lying about the numbers in some cases and a property bubble ready to pop. I'd add a lack of catalyst of mass migration of jobs from developed countries (mostly played out already) to the list of reasons to expect China to come down to earth. I'm sure it will cause some turmoil in the stock market as it's happening but I don't buy that it will significantly impact the U.S. economy. I am long the U.S. but thinking of dabbling in the wreckage of Europe. I'll look at China when it comes down to earth.

  • Report this Comment On May 19, 2010, at 2:35 PM, ChrisBern wrote:

    The S&P 500 will be lucky to break even in terms of inflation-adjusted results over the next decade. It's all headwinds right now--staggering debt, staggering deficits, states will need federal intervention soon, unmoving unemployment around 10%, the 2nd leg of the housing bubble and the 1st leg of commercial real estate is starting to drop, long-term int'l competitiveness issues, Fannie/Freddie/FHA burning money, the U.S. has mostly short-term debt so it will need to refinance--probably at higher rates, rapidly rising medical costs leading to Medicare solvency concerns. etc. etc.

    In my opinion, being long U.S. right now is a risky proposition. I'm not saying to short it, but to me the BEST case over the next 5+ years for the S&P 500 is break-even. If I were long any economy, it would be one with a fiscally conservative (read: responsible) government such as Australia. Their debt/GDP is around 20% (versus our 99%) and declining, and they've steadily raised the interest rate in recent months to stave off inflationary pressures that will undoubtedly mount in less-responsible currencies such as the USD.

    Just my 2 cents.

  • Report this Comment On May 19, 2010, at 4:45 PM, MKArch wrote:

    Unemployment always lags in a recovery and is tracking past recoveries again. Businesses wait until they are highly confident in the recovery before they start hiring back also unemployment numbers don't count people not looking for work but as the economy recovers and disgruntled workers start looking again they offset gains in hiring.

    Commercial loans were not as poorly written or numerous in this recession as in prior recessions or anywhere close to the insanity in housing, this shoe won't be the problem the doom and gloomers predict it to be this time.

    New housing starts are at an all time unprecedented low 1/3 of normal and half of the worst level prior to this recession. Also while starts were above normal in the bubble they were not significantly higher than other booms in fact the highest housing starts year in this past bubble was not even the highest on record. 1972 was the highest starts year. The doom and gloomers have already been proven wrong about the death of the U.S. consumer and they will be proven wrong about the death of the U.S. housing market. Home ownership is too well ingrained in the U.s. psyche.

    I worry about the debt as well but the improving economy will solve a lot of that. I know the Republicans have a poor recent history on fiscal responsibility but the new congress to be elected in November will have won on the platform of fiscal responsibility and will be under tremendous pressure to live up to their promises. It isn't always pretty in this country but when our backs are to the wall we tend to do what's right.

    My 2 cents, the U.S. has prospered through all sorts of issues and change over the last century plus and it's not different this time. My money is on the U.S.

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