Europe's 2013 Outlook

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In October, new IMF research revealed that fiscal consolidation by governments during an economic recovery does greater than expected damage to growth. It is a not-so-subtle message to the European Union that the prioritization of deficits over unemployment is harmful not only to a nation's domestic economy, but also that of its trading partners. In return, the ECB has responded by saying that austerity instills confidence in a nation's solvency, thus lowering its borrowing costs and setting the stage for long term growth. Although we've all heard this argument a hundred times, it is noteworthy that the ECB is defending austerity not as a political reality but as a logical solution to Europe's woes. It means that they value deficit reduction over growth.

At every point in the last two years when Greece has teetered on the edge of bankruptcy, a loan or fund transfer or bond buying program is initiated to depress their bond yields, all in exchange for painful budget cuts. To many investors, this makes the ECB "the savior of Greece" as is evidenced by the Global X FTSE Greek ETF (NYSEMKT: GREK) rising steadily since June. But let's not forget that budget cuts are usually followed by a rise in unemployment and those unemployed consume less goods and services, that means less money for businesses. Usually this is where a government steps in with tax incentives or stimulus funds, but Greece cannot afford to because they have promised to pursue a balanced budget in exchange for the bailouts. Worst of all, they don't print their own money so monetary policy isn't even an option. Otherwise they would print more money as a stimulus measure which would also inflate their debt away. Their currency would devalue, making their exports more competitive in the global marketplace, but sadly that is not their choice anymore.

During the summer, Mario Draghi said that he would do "whatever it takes" to bolster Europe's economy but we haven't seen anything close to that. "Whatever it takes" would include higher inflation targeting so he can get aggressive on the expansionary side of monetary policy. Until now I thought it was Germany's hyperinflation fears that held him back but this new ECB stance shows otherwise. They genuinely believe that ignoring short term stimulus in pursuit of long term fiscal stability is the surest path to growth. Which, in layman's terms, means that they are not the cavalry riding to Greece's rescue.

The conventional thinking for the last two years has been that "as goes Greece, so does the rest of Europe" and it's been mostly true. A Greek default would spark a crisis of confidence and dry up credit markets across Europe. The loss of faith would devalue the euro, making European exports more competitive against their American counterparts. Some of the bigger multinationals with significant exposure to Europe, like General Motors (NYSE: GM) and Ford Motors (NYSE: F) have already felt the impact of the worsening economic conditions across the Atlantic.

Of the two, Ford is decidedly in better shape to withstand substantial international losses. They have already stated an expected loss in Europe of $1.5 billion for this year and the next year as well but still managed to beat market expectations on their Q3 EPS. Three factories in Europe are set to close by 2014 which mitigates drawn out losses there, but more important is the 8% sales growth in North America. GM is more sensitive to risk, only grew 3% at home (where its market share is down to 18%), and cannot close any plants till 2016 due to labor contracts. To be sure, the industry as a whole is doing quite well but this a time rife with global risk. Europe's headwinds could extend as far as Asia or US consumer confidence could fall as a result of the fiscal cliff and Ford has a lower beta than GM, making it the wiser choice.


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