Right now, Europe is in the middle of a financial crisis. Indeed, there are some concerns about defaults on sovereign debt, and a banking crisis as individual banks borrow at high levels from the European Central Bank.
All of these European financial problems might seem a little interesting from this side of the Atlantic, but many of us are more focused on our own problems. In the U.S., there is a budget deficit and things are heating up for what promises to be an especially charged presidential campaign. In Canada, it appears that the economy is slowing down a bit, with oil prices falling and unemployment moving higher. With more immediate problems close to home, does Europe really matter?
European Problems Might Affect Your Portfolio
It’s important to realize that European problems could very well affect your investment portfolio. Obviously, if you invest internationally, you will clearly be affected by problems in Europe — especially if you invest in equities on European exchanges, or purchase bonds from European countries.
However, even if you aren’t directly invested in Europe, you could still be affected by what’s happening on the other side of the Atlantic. Here are some of the reasons that European financial problems could become your problems:
- Interconnected markets: Our world is increasingly connected — and that includes markets. What happens in Europe can affect markets in Asia and in America. Investors pay attention to that sort of thing, and investor perception can drive results here at home.
- Bank exposure: Maybe you don’t have direct exposure to European problems, but your bank might. And even if your bank doesn’t, the “too big to fail” banks probably do. European bonds, credit default swaps, derivatives and other similar investments are on balance books on this side of Atlantic. If everything goes down in Europe, it could cause serious damage to bank balance sheets in the U.S. and Canada.
- Earnings: Don’t forget the effect on earnings. The Financial Times recently reported that McDonald’s sees 40% of its sales from Europe. If European problems prompt lower sales for American companies across the Atlantic, that means lower earnings — and lower stock prices. And, of course, you can’t discount the foreign exchange realities. A weaker euro means that euro earnings from overseas translate into fewer dollars here at home for companies.
The world’s recovery from the last recession is still rather tenuous — in fact, for many ordinary folks the recession is still very much a reality. That means that if Europe sees serious problems, and experiences a real and lasting crisis, we could see another recession real soon, and that probably won’t help your pocketbook.
Unfortunately, there hasn’t been much progress made. Despite multiple meetings on the subject, nothing that fixes short-term problems now, nor anything that will prevent this from happening again in the future, has been agreed upon. The most recent meetings between leaders of Germany and France resulted in no new announcements.
Numerous European countries, including France, are on the verge of sovereign debt downgrades, and people are so concerned about safety that they are paying for the privilege of purchasing short-term German bonds. A recent auction resulted in a -0.0122% yield on six-month bonds.
So, while the world probably isn’t about to end, you do need to pay attention, and start making plans. Because this European crisis is far from over.