Will Europe Lead The U.S. Into Recession?

Below is a chart of US recessions since 1900:

I included this chart as it highlights that there have been 22 recessions since 1900 or 1 every 5.05 years. Would you have guessed they were that regular?

This chart details the US recessions since 1970:

Date of recession	Depth of recession
Nov 1973 - Mar 1975	-3.2
Jan 1980 - July 1980	-2.2
July 1981 - Nov 1982	-2.7
July 1990 - March 1991	-.1.4
March 2001 - Nov 2001	-0.3
Dec 2007 - June 2009	-5.1

German recessions since 1970 were:

Date of recession	Depth of recession
1975	-1.05
1982	-.79
1993	-.80
2003	-.13
2009	-3.5

Looking at the above data there is a clear trend of US recessions preceding German recessions often by as much as a year. The US double dip of 1980 and 81 only brought on a single recession in Germany. German recessions also seem to be about 1/3 to 1/2 of the depth of US recessions. There are no instances of a German recession bringing on a US recession.

There is presently a lot of discussion of whether the US can continue to grow despite a Eurozone recession. Based on the above data, it certainly seems possible, as it appears that German economic growth does not have a major influence on US growth. If it did we would see a very different picture emerge than that above. I would expect, if European growth has a major effect on US growth, that the recessions would be mixed with some recessions starting in Germany and some starting in the US.

So it would seem possible that the US can skirt a normal recession brought on by austerity in Europe. However there has not been a financial crisis in Europe in the period used for analysis. With the global nature of financial markets it would seem much more likely that America will fall into recession if there is a financial crisis in Europe. So what are the chances of a financial crisis?

There is a lot of talk that the ECB is not being supportive enough of individual country's sovereign debt. However there is a very good article here by James Kostohryz which highlights that the ECB balance sheet has expanded by over Eur 1trln since 2007. They are presently buying sovereign bonds with the market believing that they will purchase up to Eur 20bln each week. That would mean that they may buy Eur 1trln bonds more in 2012. I think it is key to understand the game that is going on in Europe at present. The ECB is buying enough debt to fend off a crisis but not so much that the incentive to enact change in the individual countries is removed. They are doing this by managing the rates that countries are having to pay on their debt in bands around the 5-7% rates in the 10 year bonds. This gives just enough pain to keep the balance that the ECB wants. When (if) the EFSF and ESM take over the purchases from the ECB nothing will change, the same game will still continue. Europe will stay as an open sore that will not heal for several years. This however will not, in my opinion, bring on a crisis, just a long hard recession . If there is a crisis, it will be for one of the following 3 reasons

1. One or more of the countries decides that they will be better off outside the currency union. This is likely in the long term, but for the next 6 months or more all countries will soldier on with austerity and recession. It is only when reality really bites that this will be the chosen option.

2. The bond market seizes up entirely. With the volume of bonds to be rolled over there must be a chance that the ECB's present policy will be overwhelmed. This is the unknown threat as it will depend on the total loss of confidence from banks and other major investors. However, the ECB is still there to backstop any crisis, just as the Fed was there until they decided to let Lehman fail. This is a wild card, but my gut says that it will not happen; there's too much at stake.

3. One of the Eurozone countries decides to default. If rioting and social unrest become overwhelming this will be the escape valve to head off further troubles and calm the situation. Again I can't see this imminently. In the longer term it is part of the solution that all heavily indebted countries will pursue and it will cause a crisis, just not yet. Greece is presently negotiating with individual creditors for a haircut on its debt. It is managing its default. Other countries may try this route, which will delay the crisis as the market digests the losses. It is only when the losses become too great that the system will fail. I am pretty sure that this is not imminent though.

My call is that for the next 6 months we will avert a crisis but not a recession in Europe. After that one of the above 3 scenarios plays out and the crisis will come. It is therefore possible, but not inevitable, that the US can continue to muddle through its economy for the next 6 months.

The investment implications of this are that it would seem wise to watch upcoming data from the US rather than cashing in American equities at this time, a holding pattern, neither buying more equities nor selling present holdings unless the data gives clues to the likely path. I would not in the short term sell because I feared a financial crisis in Europe. If the data continue to be better than forecast, the stock market can continue to rally. If, however, the US is headed for recession anyway (as predicted by the ECRI), regardless of any European influence, then the data will deteriorate and the market will fall. This is entirely different reasoning and your decision will depend on whether you are presently bullish or bearish on the US economy on its own, not because you fear that Europe will lead the US into recession.

This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.