European recession: The only way around is through

By Vikram Barhat | January 19, 2012 | Last updated on January 19, 2012
3 min read

The year 2011 was characterized by a string of bad news from the Eurozone. The crisis, now in its third year, has grown worse as policymakers continue to try to contain the floodwaters with pitchforks.

Can the global financial industry expect a turnaround in 2012, lead by the resolution of the European debt crisis?

Industry stakeholders are somewhat united in their outlook and predictions for Europe in 2012. The prevailing sense is that the crisis will continue to roil the global equity markets as Europe sinks into recession and a remote possibility the Eurozone will break up.

Central to HSBC’s Global Investment Perspective is that European authorities deliver a comprehensive solution to the ongoing Eurozone sovereign debt crisis.

“Officials have been applying a band-aid approach to their problems rather than tackling things early. Politicians have only acted when faced with severe market pressure, and only then delivering just enough to stem the tide. This only served to highlight the fundamental inadequacies of the Eurozone’s structures.”

In the case of Europe, the “too little, too late” approach has allowed small issues to escalate into something far more serious.

IHS chief economist Nariman Behravesh doesn’t sugar-coat his 2012 prediction.

“The Eurozone is headed for a second dip; all indications are that the Eurozone will suffer through a recession in 2012—a mild one if the region’s sovereign-debt problems are resolved, or a deep one if they are not.”

The Eurozone economies, he adds, will see negative growth and possibly, though unlikely, “a much worse recession triggered by messy sovereign defaults and/or euro exits.”

Europe will spend most of the year in a recession, according to Oliver Pursche, co-portfolio manager of GMG Defensive Beta Fund. “Despite a reasonably good performance in manufacturing among some of the northern nations, the overall weakness of the economy will cause Europe to slide into a recession,” says Pursche. “That said, the recession will be relatively mild, and the U.S. economy will not be affected.”

Greece, he adds, will begin official negotiations to exit the euro, he adds. “If Greece drops the euro in a dramatic fashion, we will see a huge flight of capital out of Spain, Italy and Portugal, into the northern countries such as Germany, Holland and Denmark,” he says. “Because of this Greece will exit in a more structured and orderly fashion. Likely, the country will negotiate to still pay fifty cents on the dollar for its sovereign debts then reintroduce the drachma alongside the euro for a three year time frame, with the decoupling occurring over time.”

Greg Nott, chief investment officer, Russell Investment Canada Limited, says the continued uncertainty in Europe means the continent is entering a mild recession and further damage to the banking sector could be on the cards.

“Europe’s troubles will continue to cause volatility in the asset markets, the Eurozone will remain intact and the odds of a recession in the region reaching North American shores is low,” says Nott.

By contrast, some analysts say things have got so bad that they can only get better.

“Despite a year of economic difficulties in Europe, I’m confident the stock markets will advance in 2012,” says Bob Gorman, chief portfolio strategist, TD Waterhouse. “We will likely be in a relatively low growth, low inflation environment that should favour large cap stocks, which generate a good part of total return from substantial, rising dividends.”

Alan Clarke, Scotiabank’s UK and Eurozone economist, offers similar views. “There is a strong chance that something good comes of [the crisis],” he says. “We are reaching a crescendo. The authorities are running out of second chances and there are now two choices; the authorities pull out all the stops and help to turn the page on a deeply unpleasant episode, or hold back and watch the Eurozone tear itself apart.”

Europe’s sovereign debt crisis will be a constant drag on its economic performance in 2012, says Brent McLean, president and CEO of McLean & Partners. “Eurozone purchasing manager indices (PMIs) have recently dipped below 50, indicating economic weakness in the months ahead, and Europe is likely headed for a mild recession in 2012,” he says. “In recognition of this weakness, the ECB cut interest rates by 25 basis points in early November, in an unexpected move to stimulate economic activity.”

Vikram Barhat