Friday, May 14, 2010

Euro "On Notice"

It cannot be said that I am more than a casual fan of the comedian Stephen Colbert. However, if I were to start my own “on notice” board, the Euro would have to be on Line #1. Apparently, a position on the “On Notice Board” is just one step away from another more ominous spot on the “Dead to Me Board.”

Now more than ever it appears the Euro is heading rapidly toward designation as personal or “currency” non-grata; and it will not be to the sounds of laughter that rings through Colbert’s television studio. The Euro has declined dramatically against the U.S. dollar over the past several days, hitting an eighteen-month low in trading early today.

So what does the Euro’s dramatic decline mean for U.S. small-caps? There is, of course, the most obvious impact on companies selling goods or sourcing materials in Euro denominations and then reporting financial results in the U.S. dollar. The Euro sales just won’t be as impressive come quarter end, but a buck will go a longer way today than it has for a while. Those companies trying to sell goods with U.S. dollar price tags will find the going tough in front of customers with a fist full of worthless Euros.

The situation is perhaps more complex than exchange rates. Most economists and market experts characterize last week’s drop in the Euro symptomatic of a “crisis of confidence.” Investors were looking for rescue package for Greece to prevent a default and provide a solid stimulus for future economic recovery. The $1 trillion package offered by European Union members to prevent Greece from defaulting on its obligations was at first warmly received. However, as the week neared end the sentiment shifted to a view that the package would not be enough. Real fiscal tightening is needed and has been pledged. That spells economic retraction.

In my view the implications for dissatisfied investors is a cause for concern. I expect business decision makers all through Europe to head to the hills instead of moving forward with capital and other spending programs. In my view, that presents a greater threat to U.S. companies doing business in Europe than exchange rates. Purchasing power in the U.S. dollar will not be enough to make up for the loss of business if European business consumers close their pocket books.

The situation could be of particular concern for smaller companies that are often not well diversified geographically to smooth over regional economic challenges. Smaller companies often have less sophisticated natural hedges in purchasing and billing that could help mitigate adverse currency effects.

This is why the Euro could be put “On Notice” by U.S. small cap companies.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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