Defaults or Bailouts? What’s Next for the Euro-Zone?
By Ronald L. DeLegge
February 5, 2010
SAN DIEGO (ETFguide.com) – “United we stand, divided we fall” is a famous line most of us know. And its application to real life events couldn’t be more apropos, especially in the faltering euro-zone.
Debt saddled nations like Portugal, Greece and Spain are testing the strength the European Union. Will member nations come to their rescue? What will it mean for the region? And finally, is it possible, even remotely so, that Europe’s financial problems spread like wildfire?
Let’s take a closer look at the hard hitting impact the euro-zone’s problems could have.
Defining the Euro-zone
Currently, there are a total of 16 countries using the euro dollar and they include Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Italy, Ireland, Luxembourg, Malta, the Netherlands, Portugal, Spain, Slovakia, and Slovenia.
During the Q4 2009, the euro (NYSEArca: FXE) climbed to 14-month highs versus the U.S. dollar. Instead of celebrating, Europe’s leaders observed an opposite and more adverse impact of a super strong euro; eroding exports. In early January, France’s President, Nicolas Sarkozy commented how this artificial strength created a “competition gap.” If Europe couldn’t win the war of worldwide currency supremacy with a strong euro can they win it with a weakened one?
A Short Lesson in Contagion
Europe’s monetary system is a textbook example of contagion. By virtue of the fact that they use the same currency, each of the 16 member nations are so intertwined with each other that their financial victories and failures are essentially shared. If you think it’s a difficult feat trying to get one country to correctly fire on all economic cylinders, you ought to try 16!
Here’s what ETFguide’s Weekly Pick/Pan wrote on January 20th: “FXE shares closed at $140.78 and more downside is likely. Various euro-zone countries like Ireland, Portugal, Spain and Greece are in financial trouble which is already causing havoc for the euro currency. Financial contagion is a huge factor for the euro because one country's financial woes become the problem of other Union members.”
So far in 2010, the stock market doesn’t like what it sees. After recording a handsome 32.04% return last year, the Vanguard European ETF (NYSEArca: VGK) is already down 8.37% year-to-date. Single country ETFs within the region like France (NYSEArca: EWQ), Germany (NYSEArca: EWG) and Spain (NYSEArca: EWP) are performing even worse.
What about bonds?
Currently, there aren’t any U.S. listed ETFs that focus specifically on bonds from troubled countries like Greece or Spain. But the SPDR Barclays Capital International Treasury Bond ETF (NYSEArca: BWX) has around 50% of its exposure to European Union countries. Thus far, BWX is down just 2% for the year.
A Cloudy Forecast with Hidden Nuggets
There are two immediate scenarios for Europe. While the worst of these are sovereign debt defaults, bailing out troubled euro-zone members isn’t far behind. The fragile state of the global economy makes either scenario daunting. Whatever happens, it will probably be cheerleadered as a positive step in the right direction. But those with an ounce of cynicism might want to avoid drinking European Kool-Aid.
Just how low will the euro dollar fall in 2010 and how can you profit from it? And will the euro’s problems work to the U.S. dollar’s advantage? ETFguide’s Weekly ETF Picks explain this and more.