by Charles Sizemore | June 8, 2012 10:52 am
Lest I be labeled a doom monger, I want to be clear on a few things. I do not believe that the eurozone will break up. Greece could — and probably will — be asked to leave sometime this summer, but most would agree that this would be addition by subtraction.
The other problem countries — most notably Spain — have shown the political resolve to do what is needed to stay in the eurozone. And the sovereign debt crisis is, first and foremost, a political problem with political solutions.
So again, the eurozone will survive.
But what if it doesn’t?
As investors, we have to ask ourselves uncomfortable questions. We also have to accept the limitations of our knowledge. Sometimes, no matter how rational or well-researched we are when forming an opinion, we are wrong. Good investors realize this and hedge their bets accordingly.
So what if I’m wrong? What if events spiral out of control and the euro as we know it ceases to be?
Today, I’m going to lay out a set of scenarios that investors could expect to see in the event that the eurozone breaks up and its member states resurrect the old currencies.
1. All former eurozone currencies would fall relative to a new German Deutschmark — even the currencies of relatively healthy economies such as the Netherlands and Finland — with the currencies of the PIIGS countries falling significantly harder and faster.
Currency collapse and hyperinflation almost certainly would follow, barring massive intervention by world central banks. And frankly, if relations between eurozone member states were to sink low enough to make dissolution a possibility, I couldn’t see coordinated intervention as a possibility. Europe would become a collection of little Argentinas, minus the juicy steaks and tango.
Currencies of non-euro European countries — such as the U.K., Norway and particularly Switzerland — instantly would soar to export-killing levels that would prompt their central banks to intervene. Major non-European currencies — particularly the U.S. dollar and Japanese yen — also would soar as potential havens from the storm. U.S. Treasuries and the dollar would soar to new all-time highs as investors had nowhere else to go.
2. Markets hate uncertainty, and in the post-dissolution chaos we likely would see stock market volatility on par with the 2008 meltdown — or worse.
We’ve all seen currency crises before; it was only a little more than a decade ago that we had the emerging-market currency and debt crisis that brought Long-Term Capital Management to an unceremonious death. When investors flee the capital markets, they do so in a hurry.
But remember that the European Union is collectively the largest economy in the world; if the likes of South Korea and Thailand could wreak havoc on world markets in 1998, imagine how much disruptive a euro dissolution would be. It would be the mother of all stock market crashes.
3. On a fundamental level, the story is more complicated. The economic dislocations likely would cause the worst recession since the Great Depression, which would devastate earnings and keep them depressed for years.
And good luck trying to value a European stock. The basic ratios that value investors use — price/earnings, price/sales, price/book value — all would be impossible to accurately calculate until the dust settled. This would be complicated further by the fact that most European blue chips have assets and sales across the European Union. I would pity the poor accountants tasked with assigning a fair market value — or even a historical value — to any of it.
I have no doubt in my mind that investors would find incredible bargains, once some sort of equilibrium was reached. But for months — and maybe years — investors would be better off staying away from Europe.
4. U.S. stocks wouldn’t fare much better. As we saw in 2008, national boundaries mean very little during a panic. Correlations among normally diverse asset classes converge to 1.
Looking at the fundamentals, U.S. companies would be facing nightmares of their own. Let’s throw out a couple examples. Coca-Cola Enterprises (NYSE:CCE) gets nearly two-thirds of its revenues from Europe, and Philip Morris International (NYSE:PM) roughly a third. Across the broader S&P 500, nearly 15% of revenues come from Europe.
5. In past currency crises, the countries affected eventually benefited from having a lower currency through more competitive exports. This would not be the case in Europe, at least not for a long time.
Think about it. Who are they going to export to? Europe’s export partners depend on European demand for their own exports. The EU is China’s biggest trading partner. But what condition is China’s economy going to be in if European demand grinds to a halt?
And the United States? The U.S. economy already is fragile; expecting robust American demand to boost European exports is simply not realistic.
6. What about commodities? Think back to 2008. What happened to most commodities then? When the markets went into “risk-off” mode, the raging commodities bull market went into a stark reverse.
When priced in the new European currencies, commodities actually might rise. That’s what happens in a hyperinflationary meltdown. But in terms of dollars and other non-European currencies, you would be looking at a major, multiyear bear market.
7. What about gold?
I could see gold going either way. I would prefer to hold gold rather than the new European currencies, of course, but I couldn’t say with any certainty whether gold would be a better haven than the U.S. dollar. Consider that gold’s 2012 price declines have come even as the eurozone roils in crisis, and you’ll get my point. Gold is a great crisis hedge … sometimes. At other times, it’s no hedge at all and falls in sync with everything else.
I’ll repeat again, I do not see the eurozone splitting apart, aside from a possible Greek ejection. But if it were to happen, you would want to be prepared. You wouldn’t want to own anything from the European continent save maybe Swiss francs or British pounds.
Love it or hate it, the U.S. dollar likely would be your best option as a safe haven. Though canned goods and shotgun shells might not be such a bad idea either.
Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, Sizemore Capital was long PM — and quite a few European stocks as well. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors.”
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