Could Europe's Crisis Crush the Dow?
Since last fall, news of the ongoing euro crisis has become less dire, the headlines more muted, and the risk of default less severe. Then, almost overnight, the bond markets roared back to life, yields began spiking in Spain, and the European Central Bank once again came under the microscope. The problems, including high unemployment and sky-high deficits, are the same, but a viable remedy is a long ways off. As downgrades become more common in Europe, the risks grow for economies with close ties, including the U.S.
Despite our current bull market run in 2012, the Dow Jones Industrial Average (INDEX: ^DJI) could be derailed if the European economy, the largest in the world, comes to a complete grinding halt. Right now, Spain and Italy appear to be the most vulnerable countries, and one will likely be the next domino to fall following the Greek tragedy of 2011. Likewise, the bond markets have forced 10-year government yields up toward 6% in each respective country, indicating weak prospects for economic growth.
While the Dow has returned over 6% in 2012, Spain's index has posted the lowest returns of any global market so far in 2012, dropping around 10% thus far. Surprisingly, however, Spain actually appears better positioned to deal with its debt issues than several other European countries, and even has a lower debt-to-GDP ratio than the euro area as a whole.
Source: Thomson Reuters.
Like much of southern Europe, Spain needs to slowly chip away at debt while also striving for economic growth. These two actions don't always go hand-in-hand, however, especially when the country has little to no control over its currency. As an analogy, imagine an unemployed person looking to start a small business. He has a marketable product, and the ambition to work, but he needs a personal loan to get back on his feet. When he reaches out to a lender, however, no one wants to offer financing on such questionable prospects. On top of the financing issues, many of his potential customers are struggling to pay their own bills and might not be interested in buying his products.
The situation sounds dire, but this is strikingly similar to Spain's predicament. Right now, unemployment hovers around 24% in Spain, almost three full points higher than in Greece. Forget about Greece being the "sick man of Europe"; Spain is well on its way to experiencing a "lost generation" among its youth. For those under 25, unemployment is an unbelievable 50%!
Perhaps the silver lining is that the markets seem to expect Europe to take the appropriate actions. Relying on Spain to simply adhere to austerity is a far-fetched proposition, though. The country needs work, and the unemployed youth need something to aspire to.
As an investor, I would stay mindful of the European crisis due to the implications it could have on an array of American companies. Luckily, business leaders recognize the tepid growth across the pond and have made moves to tap into more promising markets. While GDP growth could be minimal in Europe, countries like Brazil are taking off. The Motley Fool recognized the promise of Latin America, and pinpointed the No. 1 stock in this region. We identified this time-tested company in our recent report, "The Motley Fool's Top Stock for 2012." Find out if this stock could boost your portfolio by downloading our exclusive report.
At the time this article was published Isaac Pino owns none of the companies mentioned above. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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