While risks run high, there are plenty of opportunities for
canny financial advisors to make money for wealthy clients in the
embattled Eurozone market-if they know where to look.
First, the risks: Institutional investors have been chortling
for weeks over their latest acronym PIGS, for Portugal, Ireland,
Greece and Spain, all countries saddled with massive deficits. And
PIGS doesn't even include one of the biggest offenders, the U.K.,
which at 12% of gross domestic product is the highest among all 27
members of the European Union and now has to figure out how to fix
the problem after national elections resulted in a hung
parliament.
This maelstrom of debt is an obvious problem for fixed-income
investors in the Eurozone, but the fallout could hurt U.S. fixed
income investors, says John Lonski, the economist for Moody's
capital markets group. The impact could be dramatic: He points out
that the U.S. market was adversely affected by what was happening
in Europe in 1998. That summer caused a decline in the U.S. market
of 20%, and at the same time a pronounced widening of spreads
between corporate bonds and U.S. Treasury bonds.
This time around, Lonski postulates that investors could start
drawing some unfortunate parallels between Greece's urgent need for
a $140 billion bailout and what's happening in some of the U.S.'s
more beleaguered states. "The problems in Europe could heighten
worry about similar issues state governments are facing in the U.S.
with their budgeting problems," he says. "Credit-default-swap
spreads for some U.S. state and local governments are close to
where European sovereign credits were not so long ago. Until
there's a satisfactory conclusion to the European crisis, U.S.
bonds will be under pressure."
The U.S.' largest equities are no safe harbor either. "Half of
S&P 500 companies' revenue comes from non-U.S. sources," says
Stephen Bigger, managing director of global equity research at
Standard and Poor's (S&P). 'In a situation where a good part of
that is coming from the Eurozone, a much stronger dollar is only
going to hurt repatriated earnings," as the weakened Euro is
exchanged into the now-strong dollar.
S&P also expects a market correction of between 7% and 10%
at some point, "the sooner the better," Bigger says. S&P is
currently recommending an allocation of 45% U.S. equities, 15%
non-U.S. equities, 25% bonds and 15% cash. "That's a little high
because of the risk," Bigger says. "The potential for a market
correction is there, so we want to keep some powder dry."
However, despite the risks in Europe, there is a potential to make
money. S&P is currently underweight in healthcare, telecom and
utilities, but it's overweight in technology, materials and energy,
Bigger says. European equities are going for a song, too, adds
Jerry Webman, OppenheimerFunds' chief economist. "Equity investors
are buying some great companies for 15% cheaper than they were a
few weeks ago," he says.
Oppenheimer portfolio managers are focusing on companies that
meet one or more of the following criteria: European companies that
do substantial business in emerging markets; companies that have
some emphasis on aging (hearing aid manufacturers have been hot
lately); and European technology companies, particularly in
biotech. However, Webman says that investors shouldn't bank on
European consumers to drive demand in the near future. "We don't
yet know how those economies will pick up," he says.
In short, debt investors need to hedge their Euro
exposure-Oppenheimer's marker debt group is underweight in the
currency-but equity investors can pick up some bargains, depending
on how and where a company generates revenue. "Do your homework and
possess intestinal fortitude," Moody's Lonski says. "It's this type
of investment environment where money is made."