The Problem With Europe

Europe�s at it again, clobbering stocks as the debt crisis grabs at the headlines with both hands this morning…

Unless you�ve been living under a rock for most of 2011, it�s been hard to escape the European debt crisis that�s ravaging the U.S. stock market. Of course, if you�ve been living under a rock this year, your portfolio may be better off than most investors.

Today, I want to break down the European debt crisis into more manageable pieces, and show you why you should turn off the financial news for the rest of the year…

Like the rest of the developed world economies, European nations have been enjoying a spending spree for a long time, building a massive debt load. Unlike the rest of the developed world economies, Europe�s financial system is tied together with the euro � an important distinction. So while PIIGS countries such as Greece, Portugal, and Spain could leverage the strength of the eurozone to get ahold of mountains of debt, they can�t print money to solve the problem. At least not by themselves.

So while the debt fountain was flowing freely for the last decade, servicing that debt was no big deal; Greece could just take out a new credit card to pay off its latest credit card bill. When the financial crisis hit Europe, though, borrowing became a lot more difficult…

The word contagion has been a popular buzzword throughout the European debt crisis. It�s the idea that the connected nature of the eurozone could cause a financial crisis to spread from the weaker PIIGS countries to the more stable economies of Germany and France. To prevent that sort of a scenario, European countries adopted a Stability and Growth Pact, which restricted member countries� budget deficits and debt-to-GDP levels. In the real world, the pact has proven unenforceable, and eurozone debt has rocketed as a result.

Apparently, lawmakers� grasps on reality aren�t any better across the pond…

Today, contagion is a serious concern. While Greece is relatively small potatoes for the eurozone, the prospect of bailing out Italy (Europe�s third-largest economy) would be a different story. The complicated nature of the crisis is exactly why we�re stuck in uncertain territory this month. The jury is still out on the best way to handle the problems in Europe.

Meanwhile, U.S. stocks have been getting shellacked consistently as the impact of the drama in Europe trickles down to U.S. investors. You see, the eurozone is our biggest trading partner, and countless U.S. companies earn euros for their operations overseas. Some prominent analysts have even suggested that the impact of the euro on U.S. stocks is the reason for the high correlations that have existed in the market for the last year.

Frankly, there�s no escaping the fallout from Europe�s debt debacle. Reading most mainstream financial media, you�d think that the fate of Europe was being decided from one day to the next � and that the market was swinging wildly in reaction. Too many investors are �buying� the most recent resolution in the eurozone and �selling� the most recent misstep.

Today�s a perfect example: As I write, stocks are down nearly 2% on worries that Europe is headed for another credit crunch. Headline risk remains too high right now, and investors who try to trade around Europe are bound to get caught up in it all.

Instead, I�d suggest turning off the financial news for the rest of the year. Ignore the headlines, and instead, focus on price action that�s taking place in the broad market. From a technical standpoint, stocks still look reasonably bullish � a low risk-buying opportunity for the S&P 500 comes on a push above 1,292.