Why Italy and Greece Aren’t Harbingers for America

Two European leaders have finally �fallen on their swords� in surrender to financial realities, making way for some new, serious-minded reformist leaders. First, Greek Prime Minister George Papandreou agreed to step down, in conjunction with a new coalition government headed by Lucas Papademos, a former vice president of the European Central Bank (ECB) and an MIT-trained economist. Then, Italy�s Prime Minister Silvio Berlusconi resigned on Saturday. On Sunday, Italy�s President Giorgio Napolitano appointed economist Mario Monti as Italy�s prime minister.

It�s now up to the Italian Parliament to act. As a result of this high-level game of �chicken,� the yield on Italian bonds soared past 7% last Wednesday, before retreating later in the week. But it climbed back above that alarming benchmark on Tuesday.� Since the Italian bond market is the� world’s third-largest (after the U.S. and Japan), European banks are loaded with Italian debt. But unlike Japan and the U.S., which have their own central banks to absorb their government�s debt, keeping interest rates low, Italy cannot force the ECB to buy Italian debt.

Ironically, the new head of the ECB is also an Italian, Mario Draghi. He was previously Italy�s top central banker. He has done his part, trying to get the European Financial Stability Facility (EFSF) to buy Italian bonds. Now, maybe Draghi and Monti will cooperate to help Italy pass its necessary austerity reforms.

Here�s another reason why Europe has some new hope: Germany is adding tax cuts to its 2012 budget. Germany is enjoying its lowest unemployment rate in decades, making these cuts possible. There is a lot of liquidity in Germany and other euro zone nations, which helps offset Greek and Italian deficits.

Will the U.S. Soon Go the Way of Europe?

Essentially, Europe is having its �2008� now. We know what 2008 feels like because we�ve already been there, but I do not believe the U.S. will follow Greece and Italy into a new financial abyss. What is killing Greece and Italy is their cumulative budget deficits, which are larger than ours, relative to GDP. In addition, Europe is an unequal union of many strong and weak nations. Speaking plainly, the Italians and Greeks have run up deficits, but they aren�t able to print money or manipulate interest rates.

When euro zone interest rates were low, Greece and Italy could manage their interest burdens, but now that both countries are beset with soaring interest rates, they have hit their respective �tipping points.�

Rates aren’t likely to rise sharply in the U.S. The Fed has confirmed that it will keep short-term rates ultra-low for at least the next two years. This environment is incredibly bullish for stocks. Blue chip stocks are now paying more in dividends than in bond coupons! For example, Coca-Cola (NYSE:KO) has strong sales, rising earnings and 41% return on equity (ROE). It can borrow at 2.4% to buy back shares while paying a dividend yield of 2.8%. When a company�s dividend is higher than the cost of its bonds, the stock market is grossly oversold and undervalued.

I realize that many U.S. investors are scared, especially when they watch financial news programs that focus almost entirely on the euro zone crisis. However, U.S. companies are still beating their earnings estimates by a mile, while enjoying record-high cash cushions, which are often used to fund aggressive stock buyback programs, which in turn push up their earnings-per-share. This puts a strong floor under stock prices.

That�s the main reason why every scary day (like last Wednesday) is quickly offset by an equally strong market recovery, like Thursday, Friday and just yesterday, creating a strong anticipation of recovery after each reversal.