The European debt crisis was the by far the biggest news story of 2011, and now, as expected, S&P has downgraded France’s debt rating from AAA to AA+. Austria also got dropped to AA+, and Italy, Spain, Portugal and Cyprus were cut by two notches. Germany kept its AAA rating, along with Finland, the Netherlands and Luxembourg.
If we start to see European nations default on their bonds, and if bond yields (i.e., the cost of borrowing more money to fund the massive EU debt loads) spike to unsustainable levels, we could see a major deleveraging by banks around the globe. The real harm here is that debt defaults could be the fissure in the dike that causes the entire global financial dam to break open. A freeze-up in European credit would cause a major contraction in economic activity in the region, and that contagion would quickly spread to the emerging markets, to Asia and eventually to the U.S.
PowerShares DB US Dollar Index Bullish
If Europe crumbles, the euro will get pulverized relative to its rival currencies. That means a currency such as the U.S. dollar will attract a lot of investment capital. Indeed, a euro collapse means a flight to quality in what is still seen as one of the world’s most stable currencies — the good old American buck.
PowerShares DB US Dollar Index Bullish (NYSE:UUP) is an ETF that moves higher against a basket of the world’s top currencies, including the euro, and it’s one of the best ways to profit from the Continent’s fiscal woes.
ProShares UltraShort Euro
A much more aggressive way to play the European debt crisis and the demise of the euro is the ProShares UltraShort Euro (ETF) (NYSE:EUO). This is a two-beta inverse fund, and in this case, it means the fund moves twice the inverse of the daily performance of the U.S. dollar price versus the euro. Simply put, if the euro falls by 2% against the dollar, EUO will rise 4%. However, caution is a must when investing in EUO. The leveraged nature of the fund can bite you if you buy right before a downturn. This fund is much more volatile than a nonleveraged ETF, so don’t buy EUO unless you’re willing to accept the potential swings inherent with a two-beta fund.
iShares Barclays 20+ Year Treasury Bond
Besides the U.S. dollar, the other asset class that stands to benefit mightily from Europe’s demise is U.S. Treasury bonds. In 2011, Treasury bonds were one of the best-performing asset classes, and their stellar rise of about 30% confirmed their reputation as perhaps the ultimate flight-to-safety play.
The iShares Barclays 20+ Year Treasury Bond (ETF) (NYSE:TLT) is a great place to go if Europe starts to burn because despite America’s fiscal woes, we’re still the dog with the fewest number of fiscal fleas.
ETFs: ProShares Short MSCI EAFE
If Europe implodes, so, too, will many of the biggest stocks tied to the Continent’s fortune. A good portion of those stocks can be found in the MSCI EAFE Index, a measure of some of the biggest securities traded in the European, Australasian and Far Eastern markets.
ProShares Short MSCI EAFE (ETF) (NYSE:EFZ) is a fund that moves in the opposite direction of that index. So if bellwether stocks in this space falter, EFZ will move higher. With EFZ, you’re basically saying that Europe’s woes will take down emerging markets and Asia. And make no mistake, if Europe’s walls come tumbling down, so, too, will emerging markets and Asia.
ETFs: SPDR Gold Trust
The wild-card play here for a European demise is gold. Gold is considered a safe haven in times of international turmoil, and that means gold could sparkle if Europe gets hurt.
However, gold also is sensitive to the value of the U.S. dollar. Generally, a stronger dollar means fading gold prices and, as we’ve already stated, the dollar could get very strong if the euro crumbles. If, however, things get bad enough in Europe and global recession kicks up to dangerous levels, you can bet money will pour into precious metals. That would make the SPDR Gold Trust (ETF) (NYSE:GLD) another great ETF to own if Europe implodes.