U.S. Slowdown Bodes Poorly For European Stocks

Further proof of a slowdown in the U.S. economy shows up weekly with the most recent release of economic data. As a result, 61% of the public now believe that the U.S. is in a recession. This belief will certainly have an effect on consumer spending which drives nearly 70% of GDP-- whether or not we are actually in a recession. However, the Federal Reserve has drastically cut rates and just last week politicians agreed to an economic stimulus plan worth $168 billion to spur growth.

These monetary and fiscal policy measures should help soften the blow to the economy, and hopefully, help make the downturn short lived. Unfortunately, the European economy--which is now showing similar signs of slowing--is not flexible enough to effectively fend off this downturn.

European inflation is a persistent threat, as it has reached its highest level in over 14 years. It is this inflation concern that has kept the European Central Bank from cutting rates for the last 4 years. ECB President Jean-Claude Trichet has opined that inflation will not moderate until the second half of 2008, so it is unlikely that he will cut rates aggressively until at least that time. Economic concerns go beyond just credit tightening, as retail sales growth is down and so is growth in the service sector.

Furthermore, labor practices in Europe are more restrictive to businesses than they are in the U.S. So, it will be much harder for companies to boost their bottom line by cutting payroll costs. The regulatory handcuffing of management should not be understated because management of these companies is ultimately the best hope for salvaging economic growth.

European banks are not immune to the U.S. housing and mortgage market crises, as BNP Paribas SA (BNPQY.PK) had to freeze a couple of their hedge funds that were heavily invested in subprime loans back in August. BNP Paribas is just one of a handful of European banks that has been hurt by the same CDO’s and credit problems as in the U.S. and they are an example of the increasingly global nature of finance. However, Europe will have a harder time recovering from these issues because the economic system behind the Euro and their member countries is not flexible enough to quickly react to systemic stresses.

So, while we believe that the U.S. stock market is nearing at least a short term low, the European market could take a significant amount of time to recover.

Disclosure: None