After this week’s historic austerity measures passed by Italy, investors will be wondering how to short Italy immediately given the effect austerity measures tend to have on economies and thus, local equities, in the near-term. It’s tough to argue that the Euro region wasn’t going to have to enact austerity measures eventually to ensure long-term viability, but by tightening the spigot, history dictates that economic growth suffers in the near-term. Historical cases of tough austerity measures also draw correlations with increased civil unrest, as some have sought to blame on the UK riots following their recent austerity announcements. This past weekend, Italy’s largest unions have already threatened widespread strikes in the face of the proposal, which obviously isn’t good for economic output. At the two ends of the economic spectrum in any country, there are the usual stimulus and government spending programs which provide an artificial temporary boost and then there’s the cutting of services, government employees, increases in taxes and other measures that bridge revenues and expenses more closely. Here are multiple ways to play a weak Italy in the coming months:
EWI - MSCI Italy Index Fund – For a pure play on Italian stocks, EWI is the best instrument, holding Italian equities solely. Year to date, the Italian stock market is down 17% compared to the S&P500 (SPY) at 6%.
VGK - European ETF – This ETF tracks the MSCI Europe Index and is down 7% on the year, similar to the US. While Italy’s exposure in this fund is relegated to about 5% of the total portfolio weighting, they’re all interconnected. Just as we saw how intertwined all the European banks were with those of Greece, it’s also evident that many European banks are holders of Italian sovereign debt. As Italy’s condition deteriorates, so will that of European financials, which should weigh on the region as a whole. That could, in turn result in what we saw in US financials in 2008, which would be cuts to banking sector stock dividend payouts, which account for a substantial portion of total returns over time.
EUO – ProShares UltraShort Euro ETF – This is a play on the demise of the Euro in general. If Italy continues to crater, France won’t be far behind. When France goes, so goes the Euro. Germany would be hard pressed to continue to bail out half the region from a size standpoint and eventually Germans will revolt and demand a cessation of the union. While this is not a “likely” scenario, holding EUO is good disaster insurance. Investors should be wary of holding leveraged ETFs for extended periods of time due to the time decay that occurs in share value from daily compounding if the trend isn’t sustained. But if the Euro starts moving downward and continues unabated, EUO could hold its own for some time and provide some non-correlated returns to your portfolio, regardless of what’s happening to US equities.
More sophisticated investors may have access to other tools like credit default swaps on Italy sovereign debt, but for the routine retail investor looking to either hedge or capitalize on Italy’s impending struggles, these these ETFs may well provide a suitable alternative.
Disclosure: Author has no position in any ETFs reviewed in this article.