European meltdown likely to be felt here

As much as we'd like to report on something different this fortnight, it's impossible to ignore what is taking place in Europe.

In fact, what happens over the next few weeks and months in Europe will likely have wide-reaching consequences (and that includes for Australia).

Firstly, the core issue is that after two years of 'patch-ups' and debate there is still no agreement (or even a blueprint) from Europe's leaders on how they plan to deal with the debt crisis.

We need to remember that it's taken a few decades of debt build up and loose financial management to get to this point, so to think it can all be resolved in a year or so is wishful thinking.

Bond and equity markets have figured out there is no magic solution and are deteriorating as Europe's leaders remain well 'behind the curve'.

This week's poor outcome of an auction of German Government bonds signals the crisis is entering a new and dangerous phase as the eurozone core is coming under stress.

The attempted sale of 𔚾 billion of German 10-year bonds raised only 𔚻.6 billion, the worst outcome for a German bond sale in the history of the euro.

So if Europe's financially strongest country can't get a bond issue away then what chance does any other European government or bank have?

Germany favours reform to deal with the debt problem and is pressing debt-stricken countries like Greece and Italy to push through massive spending cuts and increased taxes to balance their budgets, in return for more funding.

But reform alone is only part of the equation. How are these countries going to service, let alone pay back, their debt while in recession?

Germany has so far resisted pressure from other countries to embrace new ideas such as issuing eurobonds (bonds jointly guaranteed by all the member states) or allowing the European Central Bank to expand its balance sheet (read print money) and become the lender of last resort.

Germany knows that you cannot solve a debt problem with more debt, or by creating liquidity, so these options only buy time and come with undesirable longer-term consequences such as high inflation.

Nevertheless, they may become more palatable compared with the alternative (a disorderly EU break up and potential financial system meltdown) if the current trend is not reversed soon.

Sooner or later it seems the markets will demand an answer and Germany better have one ready.

Meanwhile, the economic fallout is deepening in Europe and is starting to be felt across the globe. During the week the Markit survey showed the eurozone contracted for the third consecutive month in November.

After growing by a just 0.2 per cent in the September quarter, there's a good chance the eurozone is now in recession.

Also this week, the HSBC China manufacturing survey recorded its weakest reading in 32 months and is pointing to a contraction in the Chinese manufacturing sector.

As Australians, we need to remember that the world economy is linked. Europe buys from China and China buys from Australia - so what happens in Europe is highly relevant to our wellbeing.

As share market investors we need to tread carefully in the upcoming period because visibility remains poor and risks high.

·If you would like to subscribe to Cameron Bartram's weekly market update, contact him at Sentinel Stockbroking on 9225 0028 or email cbartram@sentinelgroup.com.au

_Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time. _