Moody's Downgrades Portugal and Its Banks: How to Trade (PT, IEV, EPV)

Just one day after lowering the credit rating of Portugal for the second time in less than a month, Moody's Investors Service has lowered the credit rating of seven Portuguese banks. On Tuesday, Moody's lowered Portugal's credit rating to Baa1 from A3 and said that the country could see more downgrades. Moody's followed the Tuesday sovereign debt downgrade by downgrading the seven Portuguese banks on Wednesday, citing concerns over the banks' financial situations and Portugal's ability to provide aid to its banking system. Although the Portuguese government had been saying for quite some time that it would not need a bailout like Ireland and Greece did last year, the resignation of Prime Minister Jose Socrates two weeks ago over the matter made a bailout much more likely. Portugal faces a similar problem to that of other eurozone countries that have attempted to reduce their fiscal deficits: the structural reforms needed to do so are extremely unpopular with the people. Before he resigned, Prime Minister Jose Socrates had been saying that if Portugal was going to avoid a bailout it would need to pass structural reforms that would cut spending while raising taxes. He staked his political position on a vote over the reforms, saying that if Parliament did not enact his reforms he would be forced to resign. When Parliament refused to pass the reforms and Socrates resigned, it was a sign that Portugal was even more likely to need a bailout then was thought before. As European Central Bank President Jean-Claude Trichet said, coming up with the reforms needed to reduce fiscal deficits is one thing but having the political will to enact them and see them through is another. Last year when its government was contemplating similar reforms, the Greece was engulfed in violent protests that shut much of the country down and eventually took a deadly turn. With each downgrade by Moody's, the cost of borrowing for the Portuguese government climbs higher and the lack of investor confidence in Portugal's banking system makes matters even worse. As it looks more likely that that Portugal will need a bailout from the European Union and the International Monetary fund, like Greece and Ireland did last year, investors are presented with a number of options. Portugal Telecom SGPS, S.A . PT is a Portuguese stock that trades on the New York Stock Exchange in the form of an ADR. If Portugal is able to deal with its problems without needing a bailout, the stock could see gains. If Portugal turns things around, it could be seen as a positive for other countries in the eurozone facing similar problems, such as Spain, and could push European stocks higher. If this scenario plays out, the iShares S&P Europe 350 Index IEV would see its stock price climb higher. On the other hand, if the recent downgrades of Portugal and its banks reinforce negative investor sentiment regarding several eurozone countries, the ProShares UltraShort MSCI Europe ETF EPV is an investment that would likely see significant gains.