Raising Flags Over the Eurozone

Sixty-seven years to the day after a flag was raised over Iwo Jima, the world’s attention is focused on an entirely different battle—Greece’s ongoing bailout saga. And Thursday, Greece inched closer to its second bailout after its Parliament approved an emergency bill to swap private bondholder debt for new debt at a lower face value. The measure would effectively wipe out €107 billion of the country’s debt load and mark some progress for Greece and the eurozone, but it shouldn’t be mistaken for anything other than what it is—an incremental step forward.

The past three years have shown that fireworks and additional politicking should be expected from here. For example, in order for the bond swap to prove effective, at least 85% of private bondholders must agree to it—exchanging already devalued Greek debt with new debt at 53.5% lower values, longer maturities and lower interest rates. (Although collective action clauses in the agreement could force holdouts to swap their debt anyway should a majority of the other bondholders agree.)

Plus, next week, Greek politicians must push through another round of austerity measures to cut €3.2 billion from their budget. And the full €130 billion aid package for Greece will require further parliamentary approval from some member nations—no easy feat.

In other eurozone news, the European Commission revised its EU growth estimates downward. The commission now expects the EU economy to dip 0.3% in 2012 (earlier estimates called for 0.5% growth). This news likely isn’t earth-shattering to most and in our view shouldn’t be market-moving longer term. Aside from the obvious—the eurozone is experiencing some economic troubles—the estimate also sheds light on an underappreciated factor we frequently point out in this space. Europe continues to operate as a relatively multi-speed economy, with some of the larger economies showing resilience and others (predominantly, the periphery) muddling through or contracting.

For example, recent manufacturing data showed a slump across the broader eurozone—the flash PMI (a quick-hit manufacturing assessment) came in at 49.7, just missing expectations. (Recall, readings above 50 indicate growth, below 50, contraction.) However, flash PMIs for Germany and France, Europe’s two largest economies, show continued expansion. And even within the periphery, economic data vary. Italy, for example, logged strong industrial order growth of nearly 8.0% m/m in December, compared with the eurozone’s 1.9% m/m growth.

In our view, even if the eurozone economy in aggregate is currently in or falls into a full-fledged recession (as many expect), it shouldn’t have the power to pull the United States or the rest of the world with it. We’ve seen analogous situations—with Europe, in fact, in the recent past—of local weakness not hampering global growth. Thus, given persistently dour expectations from the eurozone right now, moving forward even modest economic results should provide a nice boost to stocks.