Chances of Europe Dipping Back into Recession Sharply Increase

An update on the economic situation in Europe and a look at why the chance of another recession in Europe has increased.News comes this morning that analysts are cutting their earnings projections for European public companies by the most amount in two years.

Add to this the increasing talk that Greece will default on its loans, the continued sovereign debt issues of other European countries, and increases in the European Central Bank interest rate and we likely have Germany asking this morning, “Why did we join the European Union in the first place?”

Some major European public companies have announced that they will earn less money this year than they had previously expected. The stock markets are punishing these stocks and placing pressure on the bear market rally in stocks that started in Europe at about the same time the rally started in North America.

While my focus is in the North American economy and stock market, I wouldn’t be surprised to see several events occur in Europe over the next decade. The sovereign debt issues will not go away. The actions of past, lax, and almost socialist-type past governments will need to be accounted for. Europeans have not taken well to austerity measures—but some more are needed to bring many European countries back into debt check (keeping their annual deficit a respectable percentage of their GDP).

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Over the past couple of years, I have given considerable thought to Germany leaving the European Economic Union and severing ties with the euro. Germany has led Europe out of the recession and is enjoying strong growth. Unfortunately, it’s comingled with several European countries with severe annual deficit and national debt issues.

Italy’s debt is equal to about 140% of its GDP; Greece 170% of GDP; Spain 180% of GDP. (When you look at these numbers, the U.S. doesn’t sound bad—at debt equal to 100% of GDP.)

Given the pull-back on projected European big public company profits, the second half of 2011 doesn’t look promising for Europe. I wouldn’t be surprised to see the region fall back into recession despite Germany’s newfound economic fortune. I’ve never seen one good apple in a basket save the rotting ones.

Michael’s Personal Notes:

Friday, the Labor Department reported that consumer prices rose in April by 3.2% from April 2010—the highest year-over-year increase since October 2008. The core CPI, which excludes the volatile food and energy, costs rose 1.3%.

You know how I feel…I need to eat, I need to drive my car, and I need to heat my house in the winter and my pool in the summer. Inflation sure does feel a lot more than 3.2%.

The U.S. airline industry has successfully increased its ticket prices by 10% over the past 12 months. Most major restaurant chains, which held back on price increases during the recession, have increased the prices on their menus over the past year.

The only blessing (or curse, depending on how you look at it) is the stock market. If things pan out as I predict, and the stock market starts moving lower after the current bear market rally ends, the falling stock market will join the housing market in placing deflationary pressure on prices. (More on this on Wednesday.)

Where the Market Stands; Where it’s Headed:

Bear market usually end with a big “bang” or when investors least expect the rally to end.

While investors are back into stocks, there has no mass exodus into the market. Stock market advisors are bullish, but still 10% away from reaching the bullish level they were at in October of 2007, when stocks peaked. The number of stock advisors predicting a market correction has also risen sharply. You know how I feel. The market rarely does what is expected of it.

I continue to believe we are in a “tired” bear market rally where stocks could rally another 10% before the second phase of the bear market kicks in. You’ll have to decide on your own if you believe the 10% upside potential is worth the risk.

The Dow Jones Industrial Average opens this morning up 8.8% for 2011.

What He Said:

“Home-building in the U.S. will enter a quasi depression state in 2008 and the construction industry will make 2008 a record year for pink slips. I predict a major homebuilder will go bankrupt in 2008.” Michael Lombardi in PROFIT CONFIDENTIAL, January 10, 2008. WCI Communities, the largest U.S. luxury home builder, filed for Chapter 11 protection on August 4, 2008.