Storm Clouds Over the Eurozone

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Eurozone ETFs are doing quite well despite awful headwinds – so far.

Economist Nouriel Roubini has frequently been quoted describing the Eurozone as a “slow motion train wreck” (NYSEARCA:FXE).  At the European Union summit during October 18-19, German Chancellor Angela Merkel euro Storm Clouds Over the Eurozoneemphasized that the plan for a European banking union should be limited to “systemic” (i.e. “too big to fail”) banks, rather than all 6,000 banks within the Eurozone, as originally proposed.  During the week ending October 26, we have seen storm clouds forming over two of the Eurozone’s most troubled member countries:  Spain and Greece.

Economic chaos is regaining momentum in Spain as Prime Minister Mariano Rajoy continues to delay making a request to the European Central Bank for his country’s participation in the new Outright Monetary Transactions (OMT) bond-buying program (NYSEARCA:EWP).  During the week ending October 26, Spain’s ten-year bond yield rose 25 basis points (0.25 percent) to reach 5.59 percent.  Last week’s developments indicate the level of stress bearing down on Rajoy as he ponders his next move.  Spain’s Bureau of National Statistics reported that the nation’s unemployment rate increased from 24.6 percent in the second quarter to 25.1 percent during the third quarter – its highest level since 1976.  The nation’s unemployment rate is expected to increase during the fourth quarter, as the nation’s austerity program continues to shrink the economy.

Although the Spanish government anticipates that its economy will contract by 0.5 percent during 2013, many economists are expecting a repeat of the anticipated 1.5 percent rate of contraction for 2012.  The nation’s labor unions are calling for a general strike in November.   The Bank of Spain reported that the nation’s Gross Domestic Product declined by 0.4 percent during the third quarter of 2012.  This was the nation’s fifth consecutive quarterly GDP decline, which matched that of the second quarter.  On the other hand, the decline was less significant than the 0.7 percent decline anticipated by economists.

The next challenge to Rajoy looms on November 25.  On that date, Catalonia will hold an early election. Catalan President Artur Mas’s conservative Convergence and Union(CiU) party will likely win an absolute majority in the Catalan parliament in Barcelona.  Catalonia’s economy accounts for approximately 20 percent of the total economy of Spain.  It is widely feared that after the election, Mas will coordinate a secession attempt with Basque Nationalist Party leader Inigo Urkullu.

Meanwhile, Greece is struggling to obtain an extension of time to meet its austerity targets (NYSEARCA:GREK).  On Wednesday, October 24, Greek Finance Minister Yannis Stournaras told his nation’s parliament that Greece had obtained a two-year extension to reach its austerity targets from its “troika” of lenders – the European Commission, European Central Bank and the International Monetary Fund.  The nation’s parliament will hold two separate votes this week on austerity cuts.

A report from Germany’s Ifo Institute revealed that its Germany Business Climate Index declined to 100.0 in October from 101.4 in September (NYSEARCA:EWG).  Hans Werner-Sinn, president of the Ifo Institute, recently expressed doubt concerning the ability of the European Union to remain united.  He emphasized that the path toward joint liability for sovereign debt in the Eurozone to prevent the insolvency of any of its members would require more centralized power than is currently exercised by the Federal Reserve in the United States.  Mr. Werner-Sinn expects that further efforts to create Eurobonds or to undertake any other debt mutualization schemes will lead to a deep rift within the European Union.

Despite the uncertainty facing Europe on so many fronts, European ETFs have been doing quite well.  Let’s take a look at some:

Vanguard MSCI European ETF (NYSEARCA:VGK)  VGK has managed to make a solid advance during the second half of 2012.  It is important to note that VGK is not limited to the 17-nation Eurozone.  On June 1, VGK was trading at $39.05 per share.  On September 14, it hit $48.90 — although by October 26, it had settled back to exactly $46.

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