It's been a difficult and even tragic couple of months for the people of Europe. We've seen deadly riots, financial bailouts and market panics. All came after investors realized the Continent was ground zero of the sovereign debt crisis -- a fancy way of saying that governments there had spent too much and taken on too much debt, and were now at risk of being unable to repay their creditors.
The euro lost 20% of its value. The Greek stock market was cut in half from its 2009 high. And bond yields for vulnerable countries such as Portugal, Italy, Ireland, Greece and Spain, affectionately dubbed the PIIGS, soared as investors lost confidence and started to sell. (When bond prices fall, the yield -- the payout for owning them -- goes up.)
Traditionally seen as low-risk assets because they're backed by the power of taxation, the government-issued debts of these countries became suspect because of political realities. It would be easier for politicians in the PIIGS to renege on their promises to the market than to face certain career death at the hands of voters angered by tax increases and spending cuts.
But now, with the European Union teaming up with the International Monetary Fund to provide more than $1 trillion in rescue funds and the European Central Bank buying up troubled government bonds, is it time to be optimistic and look for bargains? I think it is.
Reasons to be brave
In fact, a growing chorus of experts and Wall Street economists is realizing this crisis was exactly what the eurozone needed to regain its competitiveness. A cheaper euro boosts the export competitiveness of European companies. And that will help the eurozone's economy grow.According to Credit Suisse research, continental Europe outperforms 88% of the time the euro weakens. The Organisation for Economic Co-operaion and Development estimates that, given the 20% drop in the euro, the eurozone will enjoy a 1.6% boost to real economic growth. Based on the euro's decline, the Credit Suisse team calculates that corporate earnings will rise 22%. These benefits are expected to outweigh proposed austerity measures to cut spending and raise taxes.
As a result, now is the time to load up on downtrodden European stocks such as Siemens (SI, news, msgs) and STMicroelectronics (STM, news, msgs).
To be sure, there are risks to this strategy. This entire episode has bought back memories of the Lehman Brothers collapse in 2008 and the resulting economic and financial turmoil. And the fear in the back of everyone's mind is that maybe, just maybe, all the efforts of governments over the past few years to resurrect the global economy haven't staved off the specter of a double-dip recession.
The chart shows the ratio of the euro index versus the dollar index, measuring each currency's strength against a basket of currencies.
Still, the road ahead won't be easy. Investors must focus on the eurozone countries that stand to benefit the most from the euro's slide. And like any contrarian countertrend idea, calling the exact bottom of this downturn is impossible. Moreover, it's likely that a few years down the road, the PIIGS will end up restructuring their debt anyway, much like Dubai recently did.
But just as the Chrysler and General Motors bankruptcies ended with better-than-expected results for creditors, I don't expect the PIIGS to completely burn their investors.
Euro pain runs deep
Expect to be ridiculed, too, because this is a very out-of-consensus idea. The main problem touted by skeptics is the likelihood of deep recessions in Europe as governments enact austerity packages to close budget deficits. In Greece, public-sector pay will be cut and taxes hiked, with a focus on fuel, cigarettes and alcohol. Spain will cut public-worker salaries by 5%. Portugal will cut salaries and raise taxes. You get the idea.As a result of the fiscal belt-tightening required as a precondition of aid packages, many economists are pessimistic. The analysts at ISI Group expect the eurozone to post 0% gross domestic product growth this year -- with "risks to the downside" -- compared with a recent consensus estimate of 1.2%. We can already see the start of this slowdown. Eurozone consumer confidence leveled off after pushing to new highs last month. And the Eurozone Purchasing Managers Index ticked down slightly in May.
Both are signs the economy is losing some momentum. And this assumes there isn't a disorderly financial panic associated with a government debt default, which would cause troubles for European banks heavily invested in eurozone debt.
According to ISI estimates, Germany should post GDP growth of 1%, compared with the consensus estimate of 1.6%. But the troubled countries on the Continent's southern flank are expected to shrink as credit market turmoil and austerity measures take their toll: According to ISI's estimates, Spain will contract by 1%, Italy by 2.5% and Greece by 5%. Not good.
Continued: Where the hopes lie