While the troubles in the Euro-zone have clearly been a major source of uncertainty for U.S. equity investors, it’s beginning to appear as if negative consequences will be largely imposed on Europeans with manageable fallout elsewhere. No doubt there’s still plenty to worry about and this assessment could be wrong, but the economic data is starting to point that way. EU-zone GDP growth of 0.2% was meager but pretty much as expected – the FT’s headline announcing that “Germany and France drive eurozone growth” seemed at odds with the numbers. Europe doesn’t look as if anyone’s driving except towards a cliff. As a result. it’s increasingly looking as if U.S. and Euro-zone growth will diverge significantly with the tail risk being for an even greater difference. Base Case forecasts from JPMorgan are for 2012 real GDP growth of 1.7% in the U.S. versus -0.6% in the Euro-zone. This is why there’s still a case to be short the €. Even without a financial disaster, plausible baseline assumptions favor the U.S. economy over Europe’s. But before you conclude that all the unthinkable outcomes have already been contemplated, read the op-Ed in the FT by Jim Millstein, chairman of Millstein & Co. Mr. Millstein argues that Europe’s banks are beyond too big to fail – they’re too big to save. The size of Europe’s biggest banks relative to their economies is disproportionate and far larger than in the U.S. If his warning of wholesale sovereign debt writedowns and bank recapitalizations comes true, new sources of private capital will be needed beyond whatever the IMF can supply. It’s a sobering scenario.

At least savers in Italy, Spain and even France are being offered a positive real return on ten year government bonds (nominal yields of 7%, 6.3% and 3.6% respectively). Given the sorry state of developed country finances every where including the U.S., it’s hard to see why anybody would lend to anyone for ten years at low single digit yields. 2% in the U.S. is derisory, and every day the Federal Reserve drives thinking fixed income investors away – to senior loans (we continue to own BHL and PPR) and to MLPs . In fact the 1 year return through October on the Alerian MLP Index AMZ is +7& compared with just 1.1% % for the S&P500 and 2.3% for REITS. MLPs are best accessed through individual holdings in order to fully benefit from the 6% tax-deferred yields available.

Dividend paying stocks remain a valid alternative. Ten year treasuries represent such poor value that only $20 in dividend paying stocks can generate the same after-tax return as $100 in treasuries (assuming 4% annual dividend growth).  A barbell, made up of cash invested in treasury bills and dividend paying stocks, is a valid alternative to today’s overpriced high grade bond market.

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