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Stocks: Will Europe continue to add to market uncertainty?

The stock market has taken a bit of a breather during April due to concerns over corporate earnings, moderation in economic growth, and concerns over the potential for a repeat of the last two years in which the market peaked in April.

So far this month, corporate earnings have been good with about 80 percent of reporting companies exceeding analyst forecasts. Also, while some recent economic indicators have been a touch softer, it is normal for economic data to modulate throughout a cycle, and the data would not portend a new recession or serious slowdown.

The other problem? Investors have begun to fret again over the European financial situation. This started several weeks ago when both Spain and Italy experienced a significant increase in interest rates in issuing sovereign bonds.

Spain recently indicated that its fiscal deficit this year would be higher than expected. Greece downgraded its forecast for economic growth. Political developments in France have raised concerns that potentially new leadership there would not be as supportive of austerity regimes in Euro countries.

While investor concerns regarding Europe are warranted, in our opinion, they may be overdone. Let’s look at a few facts:

1) U.S. combined import/export trade with EU countries is about 4 percent of U.S. GDP and about 13 percent of total U.S. import/export trade. These are not levels that have the potential to dramatically impact U.S. growth or drag us into another recession by itself.

2) The U.S. economy is large, diverse and resilient enough to generate self-sustaining growth without high levels of demand from Europe.

3) The United States is experiencing rising export demand from developing and emerging economies.

4) The IMF and World Bank have recently boosted the European financial rescue fund to $1.7 billion (increasing protection for European banks).

5) Many economists believe Europe could emerge from recession by early 2013.

6) The outlook for corporate earnings in both the United States and many developing countries remains positive.

From a financial planning perspective, one of the best ways to insulate against the risk of the European crisis is to properly diversify portfolios by both asset class and by country and industry sectors. Underweighting exposure to the Euro countries is still appropriate, in our view. Overweighting exposure to areas like emerging Asia, Latin America and the United States can provide portfolios with adequate exposure to growth.

Also, a good financial plan takes into account the fact that there will undoubtedly be good and bad periods for which one can plan. In addition to proper portfolio diversification, tools like Monte Carlo analysis and gaining a deeper understanding of client risk tolerance can increase confidence in a plan during periods of volatility while capturing returns in more attractive market and geographic sectors.

Bob Toomey is vice president, research at S.R. Schill & Associates, a financial planning and investment firm located on Mercer Island.

 

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