How to Profit From Possible Moody's Downgrade of France
Moody's Investors Service dropped a bombshell on the markets late on Monday when the credit rating agency said that it will "monitor and assess” France's Aaa credit rating.
The markets have reacted negatively to much of the recent news out of Europe. The possibility of a downgrade to France's credit rating has widened the yield spread between French and German 10-year bonds to the highest level of the euro era. European stocks fell on Monday after German Finance Minister Wolfgang Schaeuble said that it was unrealistic for investors to anticipate that a solution to the eurozone's woes would come out of an October 23 meeting of European leaders. Investors had hoped that a much talked about plan to recapitalize Europe's ailing banks would emerge from the meeting and fix many of the problems facing the eurozone.
Even if Europe's leaders manage to agree to a comprehensive recapitalization plan next weekend, the plan itself could lead to downgrades for European countries that were previously not considered to belong to the troubled and growing group of Greece, Ireland, Portugal, Italy and Spain. By taking on the risk that banks have accumulated with their holdings of bonds from troubled eurozone states, countries like France are putting their own finances at risk and could see their credit ratings lowered.
There have already been signs that the proposed plan to prop up European banks has risks of its own. Moody's Investors Service placed Belgium's credit rating on review less than two weeks ago for possible downgrade, because it was looking likely that the Belgian government would have to rescue Belgian-French financial institution Dexia SA. Shortly after Moody's placed Belgium on review, the governments of Belgium, France and Luxembourg announced a plan to save the bank with 90 billion euros in financing guarantees from the three governments and a 4 billion euro takeover of Dexia's Belgian retail banking operations by the Belgian government.
With a bank recapitalization plan looking more and more likely, the recent moves by Moody's Investors Service serve as a warning to the markets that a decision to recapitalize European banks is not a cure-all for the problems facing Europe and will simply shift risk from banks to Europe's governments.
There are a number of ways for investors to profit from the situation, depending on how it plays out.
The markets have been moving up and down depending on news concerning the eurozone. However, the trend for more than a year is for the bad news to be more concrete, while the good news is more hopeful than substantial. Investors who feel that the downward trend will continue might want to short the euro and shift their funds into safe haven currencies like the American dollar, the Japanese yen and the Swiss franc through ETFs like the ProShares UltraShort Euro (NYSE: EUO), the PowerShares DB US Dollar Index Bullish (NYSE: UUP), the CurrencyShares Japanese Yen Trust (NYSE: FXY) and the CurrencyShares Swiss Franc Trust (NYSE: FXF). While the Swiss and Japanese have fought the appreciation of their currencies, it's unknown whether or not they can keep their currencies from climbing higher in the event of a Greek default or a French downgrade and past efforts of the Swiss have been expensive and unsuccessful.
On the other hand, if Europe is able to avoid any defaults and it comes up with a recapitalization plan that doesn't lead to downgrades by credit rating agencies like Moody's Investors Service, European financial stocks could be the biggest gainers. Several of Europe's banks have were downgraded or placed on review last week by Fitch Ratings in part because they are not expected to receive the same level of state support that they have in the past. Stocks like Deutsche Bank (NYSE: DB), Banco Santander (NYSE: STD), UBS AG (NYSE: UBS), and the iShares MSCI Europe Financials (Nasdaq: EUFN) ETF could take off if the recapitalization plan achieves its goals.
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