How to Protect Yourself from a Greek Crisis

by: Alex Cook

Greece, a country that once produced Aristotle and Alexander the Great, is now facing national bankruptcy. Some kind of bailout, either from Germany or the IMF, is becoming more and more likely. A default or bailout has not happened yet, but investors need to protect themselves from a worst-case scenario in the Hellenic Republic.

What a Greek crisis would mean

The research paper for my capstone economics class in undergrad was on the financial crises in 1994 in Mexico and the Southeast Asian crises in 1997. One thing that all of the crises had in common was that the events leading up to them took years to develop, but once the crisis actually hit, events moved very, very fast. Investors who did not see or understand the events building up to the final week were left wondering what happened.

A crisis in Greece may not be severe in itself, since Greece is not as important of a world economy as Germany, for instance. However, a Greek crisis would increase fears in Spain, Portugal, Italy, and in other countries. If investors are too worried about those countries because of Greece, a crisis in those countries could become a self-fulfilling prophecy.

A Greek crisis would send shockwaves through the market, which is why a bailout of some sort will probably happen.

How to invest accordingly

Investors need to shield themselves from turmoil in the Eurozone. European sovereign debt should be avoided entirely. One strategy for hedging against a sovereign debt crisis is to short sell the IGOV exchange traded fund, which is an iShares international sovereign debt ETF with heavy European exposure, including exposure to Greece, Italy, Spain, and Portugal. Germany and France are also large holdings, but keep in mind that debt levels in Germany and France will likely rise if they are footing the bill for a Greek bailout.

Investors should also avoid exposure to the Euro currency. While Germany and France may be resilient, pressure from Greece (or additional debt levels from a Greek bailout) will keep the Euro depressed for quite some time. The obvious winner from this will be the US Dollar from a flight to quality from the Euro—but debt levels in the United States are rising as well from stimulus and bailouts. The US Dollar is likely to appreciate over the short term relative to the Euro, but I remain bearish on the US Dollar over a 12-month time horizon.

As debt levels in the United States continue to rise, investors could consider buying the TBT or TMV ETFs, which are short against US Treasuries. I initially came up with this strategy in early 2009 with the major increase in the national debt from bailouts, and frankly, it has not done much for me since. However, circumstances are different now. A European crisis combined with even more stimulus spending in the US might perhaps be decreasing the worldwide appetite for government-issued debt. If so, TBT and TMV will be good ways to hedge against government debt concerns in the United States.

Disclosure: None.