European Debt Crisis Affects Investments
Rob Silverblatt and Ben Baden

 

In a turn of events capable of giving even the most seasoned traders a bad case of whiplash, global markets snapped back to life following news that the European Union and the International Monetary Fund will set up a $1 trillion bailout fund.

The creation of the fund, which will be used to contain the debt crisis that's raging throughout the euro zone, calmed the fears of the very same traders who led a mass exodus from stock markets throughout the world. It also sent stocks soaring in Europe, Asia, and everywhere in between. In the United States, the Dow Jones Industrial Average gained nearly 4 percent.

Reports of the exact value, in U.S. dollars, of the package have differed, but according to the New York Times, the European Union will provide $633 billion in loans, while the IMF will pitch in as much as $321 billion, also in the form of loans. Apart from this rescue fund, the European Central Bank announced that it will purchase sovereign debt issued by members of the euro zone.

"What we can say for certain is that absolutely nobody out there thought that the European policymakers would be able to come out with something this large, this comprehensive, with this much breadth and depth to it," says Erik Weisman, a portfolio manager for MFS Investment Management. "In that sense, I think it is very, very positive, very bullish, and you're supposed to have a much higher degree of optimism than you had on Friday."

Perhaps the package's most attractive feature is that it aims to reduce the extent to which Greece's troubles will spill over into other vulnerable countries, such as Portugal, Ireland, and Spain. "Greece can now underperform and you have a backstop for some of the other players," says Weisman.

Despite the initial confidence boost, a number of questions remain unanswered.

Chief among them is what European Union countries will do to keep the problem from spiraling out of control after this temporary stopgap expires.

"This is a rescue operation, and a rescue operation is never going to solve the problem; it just contains the problem and helps Europe get to the next stage," says Bart van Ark, the chief economist at The Conference Board. "If this rescue package is going to work, it will contain the problem in order [for governments] to find a more structural solution."

As this situation gets sorted out across the Atlantic, investors will likely find the global markets increasingly difficult to navigate in the months ahead. In fact, for most investors, even the past several days have been nothing short of mindboggling.

Last week alone, the S&P 500 lost 6.4 percent of its value, reviving concerns that the market's breakneck rally was destined to run out of steam. And for investors who remained lukewarm about stocks even as they shot up throughout 2009, the recent falloff was a stark reminder that economy's wounds have yet to fully heal.

With that in mind, U.S. News has compiled a list of 10 investing themes that have been brought to the surface by Europe's woes. Here you'll find explanations as to what has already happened and tips for what's on the horizon:

We're all in this together.

A year ago, most investors would have scoffed at the idea that a country like Greece could upend the global economy. But the past few weeks have proven that, particularly in times of crisis, the world's stock and bond markets can all be intimately tied together. That's especially true when a major currency is threatened. Just as the collapse of Lehman Brothers showed that Wall Street can rise and fall in harmony, the European debt crisis has demonstrated that global economies are often highly correlated. "All of a sudden, it's very much the same kind of interconnected web that we saw after Lehman," says Weisman. "It's not exactly the same because there's much less leverage in the system now than there was back then. But the way it spreads around the globe is very similar."

An addiction to safety. Generally, U.S. treasuries are considered to be some of the most conservative investments out there. When investors get scared, they generally flock to safety in high-quality bonds like treasuries. That's what happened last week as investors crowded the treasuries market and drove up the prices of long-term notes. "For about a year now, there's been a lot of pessimism about U.S. treasuries," says Christine Benz, Morningstar's director of personal finance. "A crisis like this does illustrate that in a global market shock, treasury bonds are going to be some of the best-performing assets that you can have." The demand for treasuries fell on Monday as investors warmed up again to riskier assets, but last week's theatrics showed why it's important to have a well-diversified portfolio that includes treasuries.

Sovereign debt: Will it blow up again?

The amount of sovereign debt -- or debt issued by governments -- is a growing concern in many developed nations. Europe's problems may be the most severe for now, but other areas of the globe also have their fair share of issues. Paul Zemsky, the head of asset allocation at ING Investment Management, says that over the next year or two, sovereign bonds will still be reasonably good investments, but he warns that problem countries could once again dominate headlines. "There's always that inkling that at some point, the fiscal situations of these countries will become front-page news again, and interest rates could respond to that and go up," he says. Conversely, many emerging markets have balance sheets that look much healthier. Notably, they generally don't have as many deficit problems, and they're also growing at a faster rate than developed nations. "They have much higher growth, so any mistakes they make they can grow their way out of," Zemsky says.

Tricky questions for foreign bond fund investors. For bond investors, the long-term implications of the European rescue package still aren't clear. "What this does in Europe is that it kind of spreads out the pain across all the countries, but it doesn't necessarily mean it's better for the euro overall," Zemsky says. If you're in a global bond fund, it's important that you're aware of how your fund is managed. "Currency fluctuations are a big driver of how any foreign bond performs, but it's also important to know that international bond funds have different policies toward currencies," Benz says. For instance, it's crucial that you know how much currency risk your managers take on.

A rush to the door.

After a mass selloff that eerily resembled what investors came to expect during the recession, the U.S. stock market tanked last week. On Thursday alone, the Dow Jones industrial average was down by nearly 1,000 points during intraday trading. Much of this sharp falloff stemmed from bleak fundamentals coming out of Europe. But at the same time, the downward spiral pointed to investors who are still on edge in the aftermath of a crushing recession. "These things are always a confidence issue," says van Ark. As a result, don't be surprised to see similar skittishness in the market in the months ahead if investors get more bad news. As investors regain their nerve, experts expect things to calm down.

Promising opportunities for U.S. stocks.

Despite last week's falloff, some experts say the fundamentals of many U.S. companies look appealing. GDP growth of upwards of 3 percent in the first quarter, a better-than-expected jobs announcement last week, and high earnings across the board are all signs that the U.S. economy seems to be growing stronger. "In the U.S., it's a good environment for equities," Zemsky says. Quincy Krosby, the chief market strategist for Prudential Financial, says investors should consider tilting their portfolio towards large-cap U.S. stocks. "The big large-cap names have underperformed," she says. As a result, she says they're due for some broader gains.

The U.S. dollar's seesaw ride.

The beaten-up euro sent the greenback flying last week. At first blush, the dollar bill's increasing value seems like a good thing, but it can actually be quite detrimental. That's because it eats away at the profits of U.S. companies that sell their products abroad. "That can be just about any major company in the U.S. these days," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada. "Companies like GE have huge business operations outside the U.S., and that's just the tip of the iceberg." It's no surprise, then, that GE was one of Monday's big winners. During early-morning trading, its share price shot up, indicating that investors expected that the euro would regain some of its strength.

The gold rush.

Gold, which has long had a reputation as the panicked investor's best friend, shot up to $1,200 per ounce last week. But following Monday's calming news, it tumbled off of that peak. Going forward, gold investors will face a number of nagging questions. For starters, is inflation a big concern? And will investors continue to panic about Europe? If the answer to both of these questions is 'yes,' then gold may eventually continue its march upwards. "Is there an opportunity for gold to move higher? I think there definitely is," says Tjornehoj. "Are we going to see the types of returns that we've seen over the past 10 years? That I strongly doubt."

Foreign stocks.

Last week was a scary time in the global stock markets, but Monday's rally may give some relief to nervous investors. Benz says it's important that investors stay diversified outside of the United States. "You probably want to stick with significant exposure there because realistically, a big share of growth is going to come from foreign markets -- maybe not necessarily Europe, but elsewhere overseas," she says.

A short fuse.

As recently as last week, buying credit default swaps on the PIGS (Portugal, Italy, Greece, and Spain) seemed like the fashionable thing for high-net-worth investors to do. These swaps, which are essentially like insurance policies, allow investors to profit when a country's sovereign debt loses value. But Monday's news put downward pressure on the value of CDS contracts tied to euro-zone countries. "Now that the risk of default ... is backing off because of the bailout, it's possible that some of those earlier CDS purchases that were made to protect against a default could have lost quite a bit of money at this point," says Kevin McPartland, a senior analyst with the TABB Group, a financial-sector research and advisory firm.

 

 

European Debt Crisis Affects Investments

 

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