Courtesy of Daniel Sckolnik, ETF Periscope
ETF Periscope: Will these Little PIIGYS Tank the Market?
by Daniel Sckolnik of ETF Persicope
“Have you seen the little piggies crawling in the dirt?” — Lennon and McCartney
As of last Friday, selling at the beginning of May would have saved you about 300 points on the Dow Jones Industrial Average (DJIA) and around 50 points on the S&P 500 Index (SPX). You could have taken a nice three-month vacation with the savings, ignored all the financial noise in the interim, and achieved a certain level of stress-free existence, at least as far as avoiding the anxiety that often accompanies the high-volatility swings resulting from the sort of low-volume trading that occurs around this time of year.
However, if you did happen to take such a news-free holiday and, upon returning, wished to catch up on the causes of the gyrations of the market, one thing you’d likely notice is this: There’s something shaky going on across the Atlantic, and it seems to reappear with the tenacity of a large cockroach.
Certainly, a predominant theme that has run through the markets over the last three months has been the concern over the health and, yes, even the survival of both the European Union and the euro. For a while, the focus of the conversation was mostly Greece, although the word “contagion” could be heard within whispering distance. Now it seems things have shifted, and the financial news is expanding its focus more sharply to another of the PIIGS (Portugal, Italy, Ireland, Greece and Spain).
While Euro Zone leaders are holding a summit this Thursday to discuss a second bailout for Greece, it may not actually be the focus of concern. That mantle may be passed to Italy, which might easily become a far greater nightmare than Greece.
That’s because Italy, generally lurking somewhere towards the tail-end of the EU debt crisis conversation, suddenly looms as a potential “bigger domino” that could topple the Euro Zone. Italian bond yields rose sharply over the course of two trading days last week to levels not seen since the euro came into existence.
While not a total surprise, it was also not an expected event. If anything, Spain was more widely regarded to become the next “problem child” to emerge in terms of default potential, following, of course, the shaky economies of Ireland and Portugal.
Italy, however, is Europe’s leading sovereign-debt market. It has the EU’s third biggest economy, behind Germany and France, nearly as big as those of Spain, Greece, Portugal, and Ireland combined.
In other words, while a default by Greece could cause problems, the EU would probably not survive a default by an economy as intrinsic to the European Union as Italy.
At the least, it would seem a bit foolish not to recognize the potential of serious problems that could arise should one or more of the PIIGS succumb to default. The euro might collapse, the dollar would likely strengthen and the global equity markets would undoubtedly “correct” to a noticeably lower level. And while the European Central Bank and the IMF will do everything within its capabilities to halt that from occurring, they might simply not have the power to keep that particular dam from bursting.
On the upside, travel to Europe might become notably more affordable. On the flip side, if you don’t have a portfolio hedged for this event, you may not be taking too many vacations anytime soon.
What the Periscope Sees
If you think there is a possibility of the EU unraveling, here are a few ETF trade ideas that can turn highly profitable should the espresso splash across the fan.
The first ETF is VGK (Vanguard European ETF), which consistently reflects the pulse of the EU. No surprise, as it tracks the MSCI Europe Index, made up of the common stocks from 16 European countries. You’d want to short the ETF to benefit from a EU crisis. Buying puts offers a second workable strategy.
The second trade that offers big profit potential under the above circumstances is FXE (Rydex Currency Shares Euro Currency Trust). FXE tracks the euro, and measures the relative value of the U.S. dollar against it. It may even be the purer play of the two, as currencies can be more reactive than stocks. Again, short the ETF or purchase puts.
Finally, if you’re neither a fan of options nor of shorting stocks, there is another way to play the EU crisis to the downside. Consider purchasing EUO (Pro Shares UltraShort Euro). This ETF tracks Pro Shares Euro (-200) Index, and seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the U.S. dollar price of the euro.
It is important to note that EUO is a leveraged ETF. What that means is, while you can benefit hugely if the euro goes down in value, likewise you can lose as much and as fast if it goes against you. Therefore, allocate it in your portfolio accordingly, should you chose to use it at all.
ETF Periscope
Full disclosure: The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”
Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.
