Market Overview

5 Trade Ideas for the European Downgrade

S&P's downgrade of France and eight other European nations was expected, and some analysts think that Friday's rally was the market's relief that the downgrades didn't go worse than expected. Now that the downgrade is over and done, European investors are focusing on a possible Greek default. A bond worth €14.4 billion ($18.2 billion) is maturing on March 20th, and some analysts are suggesting that the country might default.

To stop that from happening, Greece will try to strike a deal with private creditors soon; talks are slated to begin on Wednesday. The nation still has two months to strike a deal, but in the meantime uncertainty will likely drive European bond yields higher and the euro lower.

Inevitably, the success or failure of those talks will resonate through the eurozone immediately. If the deal fails, eurozone nations will have to recapitalize their own banks by effectively giving Greece €60 billion. Half of that money would go to European banks and another half would go to bondholders. Of course, eurozone nations will have to agree on the bailout, and the discussion is rumored to begin on January 30th.

The success of Italian and Spanish bond sales last week may have been the eye of the storm.

If Greece cannot make a deal with bondholders and eurozone talks fail, bondholders will be forced to swap their current bonds for new ones. This will also activate credit default swaps and move bondholders to begin suing Greece.

There is also the political issue to consider; none of this is technically possible according to current Greek law, which would have to change by rushing in a new law to introduce collective-action clauses (CACs) to existing bonds, which currently do not have any in place. CACs would allow a majority of bondholders to agree to restructuring all Greek bonds. Currently, such a move is impossible. In short, the situation is a mess, so what should investors do? There are a number of plays that traders can make, depending on how they expect negotiations in Greece and the eurozone to play out:

1. Invest in, or against, the euro.

2. Buy a euro ETF or a short euro ETF. Ultrashort Euro ProShares (NYSEARCA: EUO), Ultra Euro ProShares (NYSEARCA: ULE), CurrencyShares Euro Trust (NYSEARCA: FXE), the Vanguard European ETF (VGK), and Dow Jones Euro Stoxx 50 ETF (FEZ) should respond quickly to developments in the negotations over Greece.

3. Buy or short the Greece ETF. The Global X FTSE Greece 20 ETF (NYSEARCA: GREK) was launched a little over a month ago to allow investors to play on the volatile and rapidly deteriorating situation in the troubled Mediterranean nation. Unsurprisingly, this ETF is not for the faint of heart, as it is down over 8% since its inception and has rather low liquidity, making it a tricky short-term play.

4. Play an American investment bank, especially Goldman Sachs (NYSE: GS), JPMorgan (NYSE: JPM), or Morgan Stanley (NYSE: MS). These companies will not be directly affected by the euro market because their investment in eurozone countries is minimal. However, they tend to follow developments in Europe as investors expect a global backlash (or resurgence) on the heels of news in Europe.

5. Play the biggest holders of Greek debt. Of the top 40 holders of Greek debt, a few are publicly traded. If you think a deal will guarantee bondholders get their money at current or high yields, you could invest in BNP (BIT: BNP), Allianz (FRA: ALV), AXA (PINK: AXAHY), RBS (NYSE: RDS), HSBC (NYSE: HBC), Credit Agricole (EPA: ACA). Alternatively, if you expect the deal to fail or result in low returns, you could short these companies.

Posted-In: Long Ideas News Bonds Short Ideas Global Markets Trading Ideas

 

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