It has been almost a year since European Central Bank (ECB) President Mario Draghi brought temporary respite to Europe’s debt crisis by pledging to do “whatever it takes” to save the euro.
Since then, the situation in Europe has improved. Draghi’s efforts helped reduce the financial risks associated with a breakdown of the European banking system and a breakup of the euro. In addition, over the past year, European governments have made some progress in bringing their budgets in line and in achieving some modest structural reforms.
But while the region’s situation is better than it was a year ago, Europe is not out of the woods. Much of the job of restructuring European economies remains unfinished, fiscal deficit targets have slipped and there has been little progress on broader supranational issues such as banking integration or the pooling of sovereign debt. In short, the ECB’s actions were palliative and not a cure.
So what does this mean for global investors? Here are three reasons to pay attention to Europe now.
1. Concerns over the region’s financial situation can still disrupt global markets. This was evident during the March crisis in Cyprus and recent coalition government wobbles in Greece and Portugal have already, at least temporarily, pushed up European bond yields. Worsening political instability in these two countries, or elsewhere in the region, could still hurt the 2013 rally.
2. Europe is unlikely to help foster global growth in the near term. Growth in Europe continues to contract, albeit at a slower pace than a year ago, with unemployment around a record high. While I expect European growth to improve somewhat by year’s end, a region representing roughly 20% of the global economy stuck in neutral means global growth will continue to be soft for the foreseeable future.
3. US growth – particularly for the export sector – will continue to be negatively impacted by Europe. One big reason why US manufacturing has been slow lately is that Europe is buying fewer US exports.
Unfortunately, the European political calendar, including important German elections in September, suggests that few of the region’s issues will be tackled this year.
And until Europe either turns the economic corner or addresses its lingering structural problems, I remain cautious on the region’s stocks even though they are cheap by most metrics and offer some long-term value. For now, I believe there are better near-term investing opportunities in other developed markets such as the United States and Japan.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.