The euro zone debt crisis rocked the U.S. markets, and while things have seemed a little quieter lately, don’t be fooled — Europe is reeling, and will be for quite some time. In my book, Sell Short: A Simpler, Safer Way to Profit When Stocks Go Down, I wrote a chapter on how to short a country. Maybe I should have written one on how to short a continent.
Germans retiring at age 67 on half pay are angry about being asked to pay higher taxes to bail out Greeks retiring at age 50 on full pay — and with much better weather and beaches to spend their time and money. The euro is falling due to a lack of confidence that governments can trim deficits and roll over gigantic debts, or, if they can, that the fiscal contraction will lead to a savage recession. Not to mention that many European banks are insolvent by U.S. standards.
In short, things are not looking good. So I’m going to give you three ways to turn Europe’s pain into your gain.
#1 Short the Euro
The euro has seen its longest stretch of monthly declines in 10 years, wiping out a near 50% rally from its October 2000 low to a high in July 2008. I was in Paris at that time and paid $100 for spaghetti and salad — great pasta, but c’mon.
Even though we’ve seen the euro hitting four-year lows against the U.S. dollar, it’s not too late to play the downside. The currency’s weakness is now seen as a tool to fight European unemployment, which is at a 12-year high, according to Bloomberg. In other words, there is not a lot of political support to keep the euro strong.
You should not short the currency directly, though, unless you are a professional trader or trying to give all your money away. Instead, buy longer-term put options on the euro exchange-traded fund (ETF), the CurrencyShares Euro Trust (NYSE: FXE).
#2 Short the British Pound
Unlike the whole of Europe, the Brits will accept fiscal contraction, the fancy term for budget cuts. To offset this pullback in government spending, and to increase the competitiveness of the pound, the Bank of England is going to print money through what is euphemistically called “quantitative easing.” And when you print money, you devalue your currency. In addition, Britain is the world’s fifth largest exporter of finished goods, and a pound that is too expensive means more unemployment. So down the currency will go.
Now around $1.45 versus the U.S. dollar, I believe it will go to $1.22-$1.25. This could take three months, or it could take a year, but it will happen. Since my son is beginning college at the University of St Andrews in Scotland next year, and the tuition is paid in pounds, this scenario is very welcome in my house.
For the rest of you, the trade here is to buy put options on the CurrencyShares British Pound Sterling Trust (NYSE: FXB).
#3 Short European Banks
The big European banks are in deep trouble. They have very small amounts of core capital compared to U.S. banks. Some German state banks are thought to be leveraged as much as 50-to-1. They hold enormous amounts of sovereign debt issued by the PIIGS (Portugal, Italy, Ireland, Greece and Spain) — at least half a trillion euros worth, perhaps more.
The proposed 1 trillion euro bailout of Greece and other potential train wrecks is really designed to bail out these banks. Of course, this package has yet to be voted on by participating nations. And even if the bailout happens, it ain’t big enough, and the banks have been told publicly that they will have to take some form of a hit for political reasons. The banks will need to raise capital, and that means diluting shareholders. Not to mention that the banks are going to be hit by a savage recession induced by fiscal contraction across Europe.
The big players to look at that are listed on U.S. exchanges are UBS AG (NYSE: UBS) and Deutsche Bank AG (NYSE: DB). Also take a look at Banco Santander, S.A. (NYSE: STD) and Banco Bilbao Vizcaya Argentaria (NYSE: BBVA). Consider purchasing put options on any or all of these bank stocks.