Why the Next Six Months Are Critical for All Investors

U.S. investors are starting the year 2012 with a nice positive push in equities, but caution is warranted due to the turmoil that continues in the eurozone. It appears we’re beginning to see the cracks growing larger in the euro and companies are being hit hard on that continent, especially European banks. Yes, the U.S. financials were hit hard in 2008, but make no mistake that we will feel the heat from the eurozone, as the U.S. has almost $3.0 trillion of exposure to European banks.

We just received reports that UniCredit, Italy’s largest bank, is having great difficulty in attempting to raise over $9.0 billion to recapitalize itself by issuing shares that are 43% less than the value on January 3, 2012. The bank is trading at a 19-year low and most analysts are reducing positions and recommending getting out of the bank. This is Italy’s largest bank and they have to offer a massive discount just to get any investor interest. That is not a good sign for the future of European banks. This is only the beginning for the eurozone and ultimately the U.S.

In the prospectus, UniCredit stated: “Concerns that the eurozone sovereign debt crisis could worsen may lead to the reintroduction of national currencies in one or more eurozone countries or, in particularly dire circumstances, the abandonment of the euro.” The eurozone bank also stated that the euro breakup could have a significant negative impact.

European banks and firms in other industries are preparing for the end of the euro, or at least some countries leaving the eurozone. The impact would be quite negative and no one can predict exactly what will happen, because so many investments are all mixed together. One firm has debt from another firm that they lent to yet another firm that repackages and sells that debt to firms in the U.S., which then sell it back to someone else. This spaghetti-like effect makes the matter of figuring out what will happen extremely difficult. The only thing that is known for sure is that volatility will go up and, if any firms, especially European banks, are close to the edge, investors will sell their holdings first and ask questions later.

Why are the next six months so important? The first real test will be in March, by then the Greeks will need €130 billion to cover their bills or they’re finished in this eurozone experiment. If they don’t get this money, they will default on their debts. Yes, Greece is small, but so is the first domino in front of the hundreds more behind it. This default might cause a chain reaction, as firms write-off this debt, including the European Central Bank (ECB), and we see other countries hit during the rest of 2012.

Not only will chaos reign in Greece, but also this will cripple European banks, as they will need to raise even more money if these debts go bad and other countries think about defaulting. If Italy’s biggest bank is having trouble raising money now, it will be impossible to raise money if the assets they’re holding are worth 50%- 80% less. This is what’s so scary; no one really knows what these paper assets will be worth.

I certainly will be watching this eurozone mess carefully, especially the European banks. Discussions continue with Greece, but if nothing is resolved soon, the carnage may unfold and the perfect storm may hit U.S. shores.

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