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Quarter-End Insights

Europe Markets Rise Amid Crisis Concerns

Despite all the turmoil across Europe, most markets ended up in the green in 2012.

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Investors could be forgiven for being surprised that the European stock markets actually logged positive returns of about 20% in 2012 (according to the MSCI Europe index), given the tumultuous turn of events across the continent's political and economic landscape, which occurred with unfailing regularity throughout the year.

To start with, Greek debt crisis concerns from 2011 carried over well into the second quarter, and it required an election with all the political drama of a hung Parliament after the conclusion of voting, and hectic negotiations thereafter, to finally establish Antonis Samaras as Greece's new prime minister and head of a coalition government in June.

European equities, languishing until then--and further dented by the political standoff--finally picked up steam midyear. It helped that the new government was pro-bailout, acquiesced to the European Central Bank's terms relating to austerity measures, and promptly secured the first round of funds in order to stave off default. This was achieved amid large-scale civil unrest that included demonstrations as well as lockdowns and protests of various kinds opposing the new budget cuts.

Spain's banking sector was also on shaky ground after a housing bubble threatened to push the country toward a full-blown bailout. In addition, the Spanish economy contracted 0.3% in the first quarter from the fourth quarter the prior year, marking two straight quarters of lowered GDP growth. The nation's major banks were downgraded by Standard & Poor's overnight and the ratings agency also revised its assessment of Spain's economic risk. (In May, the Spanish government finally bought a 45% stake in Bankia SA, nationalizing the troubled lender.)

European equities finally moved upward in June after a meeting of European Union leaders yielded much more than expected. EU leaders agreed to bring down spiraling borrowing costs in Italy and Spain, create a single supervisory body for eurozone banks, and implement a 120 billion euro spending package for the eurozone.

In July, ECB President Mario Draghi said the ECB "is ready to do whatever it takes to preserve the euro," giving a fillip to equity markets. The same month, eurozone finance ministers agreed to offer Spain's banking sector 30 billion euros and extended the deadline for the country to cut its public deficit to 3% by a year. Like in Greece, civil unrest greeted Spanish Prime Minister Mariano Rajoy's announcement of 65 billion euros of budget cuts to meet the new fiscal deficit targets.

On the downside, a spate of ratings downgrades in June were a dampener on investor sentiment at the end of an eventful quarter. Fitch downgraded Spain's long-term foreign and local currency issuer default ratings (IDR) to BBB from A. Moody's also lowered its ratings on Spain to Baa3 from A3 and placed the country under review for a further possible downgrade. Cyprus was downgraded to junk status by Fitch, to BB+ from BBB-, and it became the fifth country to ask for financial aid.

Moody's also downgraded Italy's credit rating two notches, citing contagion risk from Greece and Spain, and lowered its outlook on Germany, the Netherlands, and Luxembourg to Negative from Stable. And Spain's government cut its own forecasts for economic growth.

In August German Chancellor Angela Merkel followed up ECB President Draghi's comments the prior month, asserting that Germany was "in line" with the ECB and that policymakers "feel committed to do everything we can to maintain the common currency." That initially boosted shares, which received a further impetus after positive GDP data from Germany and France. But the markets pared those gains after data showed a contraction in the overall eurozone economy and Greek woes temporarily prevailed.

4Q Ending on an Uncertain Note
In the three months leading up to September, European equities were actually gainers for the most part following Draghi's announcement of an unlimited bond-purchase program and a favorable ruling for the European Stability Mechanism by Germany's Federal Constitutional Court. But the gains were short-lived, and the markets fell again, confirming the stop-start manner that had punctuated all the action in the stock markets throughout the year.

Hurting investor sentiment again, Moody's lowered the EU's Aaa rating to Negative outlook from Stable in September, citing the weakening credit worthiness of the region's biggest members. France and Germany also could not agree on when to introduce the banking union for the eurozone, and the Spanish government received requests for a bailout from a number of regions within the country.

The uncertainty continued through November, exacerbated by the political situation in the U.S. ahead of the presidential election and with markets focused on the so-called U.S. "fiscal cliff" of more than $600 billion in tax increases and spending cuts in 2013. A warning from Fitch that the U.S. may be downgraded next year unless policymakers act quickly on resolving the situation unnerved jittery investors.

Moody's also cut its triple-A rating on France by a notch on Nov. 19. Also in November, the European Commission downgraded the eurozone's economic outlook, and Draghi said the Central Bank expects the economy to remain weak in the near term and that recent data indicate the German economy is increasingly being affected by the region's debt crisis. Economic reports showed the eurozone economy contracted 0.1% in the third quarter after contracting 0.2% in the immediate prior quarter.

Major Markets
Despite all the turmoil across Europe, only the Greek and the Spanish stock markets ended up in the red. The Greek markets were down 2.5% for the year, while the Spanish markets fell 1.9%, according to MSCI data. The major markets of Germany, France, and the U.K. were up 28.1%, 19.1%, and 11%, respectively, through Dec. 28.

Sector performance saw IT stocks gaining 26%. Pure-play software and services companies were among the best performers within the industry, up about 45%. Stocks like  Capgemini (CAP) and enterprise software specialist  SAP (SAP) gained about 35% and 50%, respectively, year-to-date.

Financial stocks put in a respectable performance, with banks up about 29% while insurance stocks returned about 37%. In banks,  BNP Paribas (BNP) returned about 36% year-to-date, while  Societe Generale (GLE) was up a whopping 60%.  Crédit Agricole (ACA) gained about 37%. Over in Frankfurt, banks gained, but not nearly as much, with  Commerzbank AG (CBK) up about 7% while  Deutsche Bank (DB) added 14%.

Rouhan Sharma does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.