Stock Returns Strong Despite Eurozone Weakness

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- In our view, stock returns are strongly positive in 2012 and the world overall grows, even though the eurozone is likely a weak spot and may even go into recession in aggregate.

And we needn't look back that far to see a similar scenario historically. The early 1990s featured a global recession before the rest of the world recovered while Europe re-entered a recession tied to a pan-European monetary disarray. (Sound a bit familiar?)

Our history lesson begins in 1979, when the EU's Exchange Rate Mechanism (ERM) -- the precursor to today's euro -- began. Through the ERM, each participating nation's currency (eight nations in all at the start, including West Germany, France, Italy and Denmark; the UK joined in 1990) was pegged to the European Currency Unit, a quasi-European currency.

Based on a basket of currencies, the ECU existed largely as an accounting unit, though it was eventually noted on travelers' checks, certificates of deposit, etc. The idea was to slowly converge national currency valuations in anticipation of adopting the euro, so the common currency wouldn't require huge economic adjustments (the blueprint for the Maastricht Treaty's Conditions for Convergence).

But because of the deutsche mark's relative strength and the German Bundesbank's hawkish monetary policy, the mark (and West German policy) became the center and driving force of the ECU. This eventually caused rather painful currency dislocations (more on this in a bit).

Fast forward to 1990, when the US Savings & Loan (S&L) crisis kicked off a global recession (a US-led recession based on banking weakness -- rather like 2007-2009). The impact in continental Europe was somewhat muted, but the UK felt it acutely since British Building Societies operated similarly to S&Ls.

Italy, Spain and Portugal's GDPs shrank in 1990-1991. The Nordic states were weak, too --particularly Sweden, which had a real estate crash. Yet Germany grew robustly in 1990, prompting inflation concerns in West Germany during the early stages of reunification. Similar to now, growth was divergent, as was competitiveness from a unit labor cost standpoint.

Following the 1990-1991 global recession, much of core Europe likely could have used accommodative monetary policies to goad growth. But that wasn't an option. Why? The Bundesbank didn't need to stoke German growth but sought to restrain the mark, strengthening the ECU's relative value.

Since the ERM allowed member nations to deviate only marginally from fixed exchange rates, central banks eventually and reluctantly followed Germany's tightening. Thus, their foreign exchange reserves dwindled, GDP fell again across the continent -- a regional "double dip" -- and by fall 1992, the crisis reached a breaking point. On Sept. 16, 1992 ("Black Wednesday"), currency speculators "broke" the Bank of England, and Britain subsequently exited the ERM. But the mechanism's unraveling -- and the European recession -- continued into 1993.

The economic fallout from defending, then later discarding, currency pegs was obvious across Europe in 1992 and 1993 -- but the U.S. and world overall grew, as shown in the chart below.

And perhaps more important for investors, global stock markets proved resilient to Europe's woes. In 1992, world stocks measured in U.S. dollars were down a little -- nearly identical to 2011's small drop. But they rose a hefty 22.5% in 1993, even though much of Europe was in recession as the year began! Why? The problems were Europe-specific and the world overall was fine. What's more, stocks move first. World stocks likely priced in Europe's weakness in 1992 and in 1993 were pricing in better times ahead -- the global economic boom that would last the rest of the 1990s.

Recent economic data suggest much of the world is doing fine or even accelerating. History never repeats perfectly, but we anticipate markets can have a similarly robust retort to European weakness in 2012.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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