For months now, European leaders have been struggling to keep the powder keg that is Greece and its debt from exploding, and as we head into the end of the year, the fuse still seems to be hissing toward the barrel of dynamite that could blow up Europe and the world.
Last week, Greece took investors on a roller-coaster ride as Prime Minister George Papandreou dropped a bomb with his announcement and subsequent retraction of a national referendum regarding the European bailout program.
On Friday he survived a no-confidence vote, but by Sunday it was clear that a new government would be formed and that Papandreou is out. As of Tuesday morning, an interim prime minister had yet to be named, but this fast-moving situation is rocking investors worldwide.
Meanwhile, Italy’s 10 year bond reached a euro-era record as that embattled country deals with its own economic problems and demands for structural reforms from the International Monetary Fund.
Of course, Italy is the far bigger elephant in the room, and it’s government is tottering on the edge of disaster. Its debt is a seemingly insurmountable mountain, and so danger could still lurk ahead even if Greece installs a new government and works with the European Central Bank to manage its debt.
The “powers that be” seem stymied by the whole situation as the G-20 summit meeting this weekend ended with no concrete action. Apparently, no one in the G-20 wants to participate in the European bailout package, except maybe the IMF which, along with the ECB, is likely to become Europe’s “lender of last resort.”
So with a new government coming to Greece, Italy on the edge of the abyss, and the euro zone slipping into recession, this fluid situation promises to be on the front burner for weeks to come.
Still, for investors, great dislocations like these offer potentially great opportunities, and here are a couple of ways that one could use exchange-traded funds to seek play the unfolding European crisis.
If you believe Europe isn’t going to make it, shorting a country ETF like Italy via iShares MSCI Italy Index Fund (NYSE:EWI) or the euro itself via Rydex Currency Shares Euro Trust (AMEX:FXE) could be a viable option. One could also consider inverse ETFs, which move opposite the direction of the underlying index. ProShares Short MSCI EAFE (NYSE:EFZ) offers inverse exposure to Europe, while ProShares UltraShort Euro (NYSE:EUO) does the same for the currency.
Chart courtesy of www.stockcharts.com
For investors who believe that the ECB, Germany and France will be able to dodge this bullet one more time, impressive opportunities could be found in going long Europe via country ETFs or currency ETFs as described above.
My view on Europe goes like this:
The macro picture tells me Europe will likely survive this round of the crisis, so long positions in Europe could be the appropriate bet for now. The ECB can still fire its “bazooka” and monetize the debt by buying lots of bonds, something that it is loath to do. But that is a step it most probably will be forced to take to avoid Armageddon and a “Lehman Event” in Europe.
However, somewhere, sometime (and nobody has a crystal ball as to when this might happen), it’s likely that Italy or Portugal or some combination of the peripheral states will pull Europe into an inescapable vortex. And at that point, a short orientation to the Continent would be in order.
For today and going into the end of this year, Europe will probably successfully defuse its powder keg, maybe for the last time. The likely final outcome is that one day spontaneous combustion will ignite the spark that hisses unstoppably at Europe’s debt-fueled dynamite.
Disclosure: Wall Street Sector Selector actively trades a wide range of exchange-traded funds and positions can change at any time.
John Nyaradi is Publisher of Wall Street Sector Selector, a financial media site focused on news, analysis and information about exchange-traded funds and global financial and economic developments. To sign up for his free newsletter, click here.
