One of the key drivers of the stock market's strength until recently was bountiful corporate earnings. Many of those profits were made by the foreign affiliates of American companies—and Europe is responsible for about half of those overseas profits. If Europe enters into a recession, those profits will decline, which will likely weigh on U.S. stocks.
Europe’s governments are embroiled in a debt crisis that some fear may be too big to be resolved. It’s not just Greece anymore. Italy, Spain, and France have come under pressure in recent weeks. Even Germany's economy appears to be slowing. As the trouble spreads from the peripherary of Europe to its core, the idea of some countries bailing out others becomes murkier. If they all falter, there may be no one left with enough economic heft to mount a rescue.
The financial sector in Europe has come under particular pressure, in part because the highly leveraged European banks hold so much sovereign debt. Rumors and fears of bank failures threaten to create a liquidity crisis for the most embattled banks.
Those debt fears can have ripple effects for the financial sector in the U.S. American banks are on the other side of many trades with European banks, which means a banking collapse there could lead to losses here. More importantly, European banks have been suppliers of liquidity to U.S. financial institutions and money markets. If they become distressed, U.S. markets may enter a credit crunch.
In short, we’re deeply entangled with Europe. And markets are likely to react to any headlines—or even just murmurs—about the health of European institutions and its economy.
Questions? Comments? Email us atNetNet@cnbc.com
Follow John on Twitter @ twitter.com/Carney
Follow NetNet on Twitter @ twitter.com/CNBCnetnet
Facebook us @ www.facebook.com/NetNetCNBC