Strategies: In Europe’s Crisis, 17 Moving Parts

Finland?

For all its virtues, that small Nordic country hasn’t grabbed much global attention lately. But thanks to the quirky political and economic structure of Europe, last week Finland had the power to send financial markets into a tailspin.

As it turned out, the Finns didn’t throw a wrench into the financial gears. But that they were in a position to do so provided yet another reason for shaken investors to hide in the nearest bunker.

How did it come to this?

The euro zone has been a source of global instability for months. In the latest episode, Finland, which has an impeccable credit rating, was asked to approve a measure that would aid its improvident southern neighbor, Greece. The Finnish Parliament had grave reservations — it is already contemplating writing off some of its direct loans to Greece. But mindful of the possible consequences, the Finns voted to strengthen a European bailout fund, the inelegantly named European Financial Stability Facility.

That got world markets through Wednesday, but it hardly ended the European financial crisis — even this phase of it. The next day, it was Germany’s turn. After weeks of fierce debate, Parliament passed the measure in a 523-to-85 vote. On Friday, Austria gave its approval. And between now and Oct. 11, Cyprus, Estonia, Malta, the Netherlands and Slovakia will all have their say.

After that, if all 17 euro zone countries have granted approval, the newly empowered 440 billion euro fund (about $600 billion) will be available to give Greece some succor.

“There are a lot of moving parts and a lot could go wrong,” said David J. Kostin, the chief United States investment strategist for Goldman Sachs. “And these macro issues are dominating micro ones like whether a particular company in the S. P. is having a strong quarter — and many of them are.”

For months now, investors have been putting money in a traditional haven — the United States Treasury market, whose appeal has been burnished by the accommodative monetary policies of the Federal Reserve.

For stocks, though, a vicious circle has developed. The global economy is weak, and stocks worldwide have trended downward.

“The direction of the markets is being determined by geopolitical uncertainty on three continents,” Mr. Kostin said. China’s possible slowdown, the disappointing economy in the United States and the European financial crisis are all weighing on the markets, he said, with the European predicament likely to be front and center over the next several weeks.

In the case of the European Financial Stability Facility, political leaders and central bankers involved in the rescue effort already appeared to know it wouldn’t be enough to resolve the crisis. A vastly greater financial commitment is needed to prevent the crisis from spreading, many analysts say.

The European Central Bank may use some of the fund’s money as collateral for making larger loans, effectively “leveraging” the fund and giving it more firepower, but the bank’s powers are circumscribed. Any further fundamental changes must also be approved, one by one, by each country in the monetary union.

That is because the euro zone is not a fiscal union or a sovereign state, and its founders didn’t prepare for the eventuality that one of its members might be unable to pay its bills — threatening the stability of banks, countries and markets worldwide. Furthermore, as things stand, it’s not clear that the European Union is capable of achieving even the level of governance — some would call it dysfunction — that has lately characterized the United States. This helps explain why the European crisis has, if anything, been even harder to resolve than the still-simmering one on this side of the Atlantic, and why these linked crises are not about to disappear anytime soon.

On the American side, with unemployment at 9.1 percent and the economy growing at an anemic rate, Congress and the White House have been unable to agree on another fiscal stimulus plan — or even on whether further fiscal stimulus is wise. And a Congressional special panel must find $1.2 trillion in budget cuts in time for a Nov. 23 deadline, or else the government will make across-the-board cuts to achieve those savings.

For its part, the Fed has been engaging in monetary stimulus. Its latest foray into unorthodox policy making, known as Operation Twist, is explicitly aimed at lowering bond yields. Because prices and yields move in opposite directions, the Fed’s avowed policy is contributing to a long-running bond market rally.

That implies further problems for the stock market, Bank of America Merrill Lynch suggested in a research note last week. “There can be no bull market in equities in the medium term without a bear market in bonds,” the note said.

With the threat of another recession high, the stock market has been volatile and range-bound and is likely to stay that way until the bond market rally ends, said Michael Hartnett, chief global equity strategist at Bank of America Merrill Lynch. For that to happen, he said, it “would mean that Bernanke Company will win the war against deflation, which is obviously what they’ve been up to the last couple of years.” Such a victory “would go hand in hand with much better economic conditions,” he said, and demand for riskier assets like stocks would rise.

For now, though, uncertainty reigns, not only in Europe and the United States but also in the Chinese economy, where efforts to curb inflation may also be throttling growth. Still, Mr. Kostin said, the profit outlook remains strong among the global corporations that dominate the Standard Poor’s 500. He expects that the index will rise in the fourth quarter — closing modestly higher, at 1,250.

But in today’s global economy, many little things can easily go wrong. If they do, he said, investing in stocks, particularly in individual stocks, is likely to be very difficult.

“The macro story is dominant,” he said. And it hasn’t been a very upbeat story.

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