When we woke up on February 1st, few of us knew what PIIGS stood for. Today it’s on every lip as the European Union faces its biggest test since formation.
To understand the European Union visit the Fields of Flanders to view rows and rows of crosses that mark a small portion of the graves of the 16 million that perished in the First World War. After the Second World War, the desire to bind Europe together so tightly that future wars would be impossible and unthinkable trumped economics as the driving force for its creation. Membership required overcoming intense nationalism and individual interests to cede authority to a system of common rule making and laws.
Those rules require each member state of the common currency (Euro) to maintain fiscal standards. The advantages of a common currency are enormous, but enforcement of the standards proved challenging. Various members of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) continued to spend like drunken sailors. In the old days, a country that allowed its fiscal policies to get out of control would see its currency devalued. But, devaluation of the Euro to accommodate Greece will not sit well in Berlin or Paris. For the second time in a generation the Germans are reminded to be careful what they wish for. Having absorbed tremendous costs to re-unify Germany, they are now faced with bailing out Greece to preserve the integrity of the Euro. So, the continent is facing both an economic and political challenge pitting the haves against the wastrels.
Uncertainty surrounding the terms, timing, and extent of the bailout has in fact impacted the Euro. Hedge funds and other speculators have shorted the currency sending it down about 10% in just a few weeks. A falling Euro has implications for investors in the US. Our foreign holdings encounter a headwind as the dollar strengthens against other currency which is demonstrated nicely by a review of last month’s performance data where domestic holdings did quite nicely, and foreign holdings withered. Multi-national US corporations are impacted to the extent that their foreign earnings will be worth less, and nobody wants to see Europe’s economic recovery delayed by a new crisis. All the proceeding contributed to more volatility than normal during the month for markets everywhere.
As you can plainly see, foreign diversification doesn’t add value every month. But, over time we are convinced that our globally diversified portfolio is both prudent and wise.
Toward the end of the month word of agreement to rescue Greece encouraged investors, but they remain cautious as events unfold. Of course, investors are always considering the implications of every new piece of news as they attempt to forecast future returns. But, news by definition is unpredictable, and forecasts notoriously unreliable. History demonstrates the importance of maintaining a long term perspective and ignoring the noise while maintaining the appropriate exposure to the world’s markets.
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