How to play it: European debt downgrades
(Reuters) - The other shoe has dropped.
Standard & Poor's slashed the ratings of nine European nations on Friday, and reassessed the credit worthiness of most of the euro zone. Germany, the bloc's largest economy, was spared.
France and other sovereign bonds suffered a one-notch downgrade while Portugal, Italy, Spain and Cyprus were cut by two notches.
The moves come about a month after S&P warned that high borrowing costs and political stalemates would result in downgrades in several countries that use the euro.
With Europe's debt crisis behind much of the stock market's recent volatility and S&P's downgrade of U.S. debt in August, many investors considered ratings cuts in Europe all but inevitable.
Here are some steps that investors can take on how to play European debt downgrades, over both the short and long term.
One of last year's best investments may continue to gain over the short term.
U.S. Treasury bonds rose on Friday, sending their yields down to 1.84 percent, as investors sought out safer assets. While that's below the rate of inflation, the move suggests concerns that low yields will scare off investors look to be unfounded, said Michael Hood, a market strategist at JPMorgan Asset Management in New York.
Investors face "a set of forces that are likely to cement very low bond yields for markets like the U.S., Germany, the UK and Japan for an extended period of time," he said.
The iShares Barclays 7-10 Year Treasury ETF (IEF) is one ETF option for investors who are seeking safety. The fund, which charges 15 cents per every $100 invested, has gained nearly 16 percent over the 12 months.
The euro, meanwhile, may have further to fall, analysts said. "I wouldn't say at this point all the bad news is baked into the euro, and I don't know how anybody could say that," said Todd Petzel, chief investment officer at Offit Capital Advisors in New York.
The euro's fall will likely send the dollar higher as well. That could make ETFs like PowerShare's DB Us Dollar Index (UUP) a good speculative bet, analysts said. Nearly 60 percent of the fund's gains or losses come from the dollar's value compared with the euro.
Investors looking to short the euro could turn to the CurrencyShares Euro Trust ETF (FXE), which focuses solely on the euro's movements against the dollar. The fund charges 40 cents per $100 invested, making it one of the cheapest options available for investors looking to track the euro, noted Michael Rawson, an analyst at Morningstar.
Large debts alone aren't the reason why the outlook for Europe is dimming. The continent also is facing a likely recession, an aging population and limited prospects for long-term economic growth.
Investors are instead turning toward stocks and bonds in emerging markets like China and Brazil that may have been considered riskier than Europe in the past.
Petzel said his clients are bullish and attracted to emerging markets. "It's a volatile place but they understand there is fundamental growth," he said.
Emerging market stocks fell broadly in 2011, compared with a flat performance for the S&P 500. "We believe that, with the emerging markets about 35 percent below their historic trading ranges, this is not a year for Europe but for the U.S. and emerging markets," said Ron Weiner, president of RDM Financial Group in Westport, Connecticut.
One of Weiner's picks: the Matthews Asian Growth and Income Fund (MACSX), a $2.9 billion fund that recently reopened to investors. The fund, which owns a collection of stocks and bonds throughout Asia, yields 3 percent.
"Things are shaky (in the short-term), so we want to get paid a dividend while we are waiting," he said.
Investors are taking other steps to limit their exposure to Europe. Scott Kimball, portfolio manager of the $97 million BMO TCH Corporate Income fund (MCIIX), is shying away from sectors like financials and industrials that rely on Europe for a relatively large portion of their revenues.
Instead, he's buying corporate bonds for U.S. technology and telecommunications companies. "While sales in Europe may slow down, their big growth driver is in Latin America and the U.S."
Kimball is also looking for value. One pick: Spain's Telefonica. While the company is the dominant telephone and wireless operator in Spain, some 60 percent of its customers live in Latin America. "Where they are domiciled has been weighing on their spreads, but their earnings are extremely well diversified," he said.
German stocks may offer another way to play economic growth in emerging markets and the U.S., analysts said. The weakness in the euro will likely benefit German exporters, who make up a majority of the country's DAX index by making their products cheaper abroad.
"We think the DAX is the place to be within Europe but I think that ... is likely to work over the medium term rather than in the short run, because internal correlations have been high and tend to spike in times of uncertainty," said Hood, the JP Morgan strategist.
(Reporting By David Randall and Rodrigo Campos; Editing by Walden Siew)
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