Trouble in the PIIGS-PEN (John Stephenson)

Trouble in the PIIGSPEN

Sell orders poured into the markets last week as nervous investors began to wonder if Greece is Europe 's Lehman Brothers. Last Thursday the S&P500 stock index plunged 3.9 percent on the day, as fears of an ever-widening European debt crisis impacted stock markets around the world. In a matter of weeks, stock markets have erased their yearly gains as investors' moods have shifted from enthusiasm about a global economic rebound, to growing worries over sovereign debt defaults. John Stephenson - Money Focus Editor.

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A fragile recovery in the U.S. , coupled with emerging evidence that China 's economic growth is beginning to slow, have helped exacerbate the concern. Investors are primarily worried about Portugal , Italy , Ireland , Greece and Spain —collectively dubbed the PIIGS”—because of their high levels of government debt and the persistent worry that one or more of these countries will default. At the center of the problem is Greece , which accounts for just two to three percent of Europe 's overall economy. But while Greece is small in economic clout, it is enormous in terms of the sheer scale of both its deficit and debt—making the country for all intents and purposes insolvent. And because of the worry that a Greek default could push the world back into another slump, European leaders were quick to act by announcing a $1 trillion shock and awe campaign designed to bolster investor confidence in the euro and to show a cohesive front in the face of crisis. Debt defaults are nothing new, but depending on which banks and financial institutions are involved, and their relative exposures to small debt-plagued nations, the repercussions to a default on government bonds can be anything but run-of-the-mill. A crash in the Thai Baht in 1997 ushered in the Asian Financial Crisis, which threatened to envelope the world in an economic meltdown due to financial contagion. To be sure, the hazard lights have been flashing for Europe for some time. With international debt markets now firmly closed to Greece and a contagion threatening to envelope Spain and Portugal , Europe had to act. The European Central Bank (ECB) is extremely worried that a debt default by Greece would set in motion a fast-moving chain of events whereby the cost of borrowing would rise dramatically for the PIIGS as investors worried about the likelihood of further defaults. Dramatically higher borrowing costs would in themselves increase the likelihood of future defaults creating a situation that could quickly lead to a vicious downward spiral for the PIIGS and Europe as a whole. The announcement of a nearly $1 trillion package of loan guarantees was meant to calm jittery markets and stem the crisis of confidence plaguing the euro. But the spectacle of Greeks rioting in the streets and dithering politicians only solidified the impression among investors that Europe 's debt crisis was still spiraling dangerously out of control. Investors fear a no-win situation and they wonder if in the face of mounting resistance, government resolve will weaken—raising the likelihood of a longer and deeper debt crisis. With panic indicators such as the VIX index hitting levels not seen since the Lehman Brothers bankruptcy, investors should exercise caution. While it appears as if an immediate default by Greece is unlikely, there is absolutely no doubt that Greece will be a certain future default. The stock market's performance over the next few months will be impacted by the level of resolve shown by both the ECB and the European Union in containing this crisis and the success of the austerity measures recently enacted. Investors are encouraged to high-grade their investment portfolios and raise cash levels as a defense against further market turmoil.

John Stephenson Money Focus Editor .