Spain Reminds Us That The Worst Is Yet To Come In Europe

Includes: EWP, FXE
by: Kevin Mahn

Spain, which has the fourth largest economy in Europe, is currently struggling with high unemployment (the highest unemployment rate in Europe), increased borrowing costs, a stressed banking system and rising tensions amongst its citizens as it relates to austerity measures being considered by Spanish Prime Minister Mariano Rajoy. Does this sound all too familiar? Take out the word “Spain” and insert the word “Greece,” and the first sentence might have been the beginning of one of our market commentaries from several months ago.

The saga in Europe continues as economic and political tensions continue to escalate. ECB President Mario Draghi pledged this summer to “do whatever it takes” to preserve and protect the euro. In doing so, he essentially pledged the financial resources of the ECB to help stave off a full, blown-out banking crisis in Europe. In the case of Spain, the ECB has granted a €100 billion ($128 billion) loan commitment for its own banking system. A government commissioned audit will release details on Friday about which banks are in need of funding according to their own stress tests, although it is anticipated that some banks may not need any aid and the total funding needs may be significantly less than €100 billion. With the ECB aid, however, comes the request for a commitment to austerity measures. In this regard, Spain is rumored to be considering new spending cuts and restrictions on early retirement to help balance its own fiscal budget woes. This has led to great unrest in the streets of Madrid in recent days, similar to what we saw not so long ago in the streets of Athens.

Europe finds itself in a similar situation today to where the U.S. was back in 2008, and is using several similar remedies to try and restore fiscal order following several years of excessive spending and real estate development. They have even proposed setting up a similar “bad bank” to what was employed in the U.S. to hold distressed assets.

Solving Europe’s debt crisis will not be easy, as any country-specific fiscal remediation efforts in Europe are complicated by having to coordinate the opinions of 26 other member countries and factor in the larger scale implications on the European Union (NYSEARCA:EU). Overall, the best chance of lasting reform in the eurozone, in our view, involves Greece being quarantined for now, with the additional ECB funds that are available being used to stabilize other struggling European countries in conjunction with the gradual implementation of realistic austerity measures.

A couple of more immediate concerns to us, however, are the intensifying recessionary pressures in Europe and the likelihood of the European recession hindering the lackluster global economy. To help appreciate the potential impact, The Economist estimates that the EU’s share of worldwide gross product is approximately 20%.

We would contend that the European recession is likely still in its beginning stages, and the worst may be yet to come in Europe as we move along in the game.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.