Greece is Europe's equivalent of the U.S. subprime mortgage market in 2008. It is a small component of the overall economic pie, but its failure could create cascading catastrophic effects on the entire European economy.
A Greek default would likely trigger a widespread risk aversion, sending European sovereign bond spreads wider and possibly sending other nations into default. The European banking system could freeze as investors and financial institutions take a shoot-first-ask-questions-later approach to lending -- perhaps justifiably so, as European banks are heavily exposed to the sovereign debt of EU members.
A contagion may be stoppable, but the political appetite for bailouts is far lower than it was in 2008. German citizens have no desire to bailout their free-spending neighbors. And although the European Financial Stability Facility has set aside billions to tackle a crisis, this fund raises its capital from the markets and is ironically backed by the very European members it is meant to bail out.
Needless to say, there is a meaningful risk that, if Greece defaults, Europe quickly degenerates into financial chaos and massive economic contraction.
Judging by the abysmal performance of many European companies, investors are already anticipating the first-round effects of a default on European domestic demand:
- Koninklijke Philips Electronics NV (PHG) down 41% YTD
- Ryanair Holdings plc (RYAAY) down 18% YTD
- France Telecom SA (FTE) down 21% YTD
Many investors wishing to profit from a Greek default have done the obvious by focusing on European stocks, indexes and CDS. What many investors may not be anticipating are the less obvious second and third-round effects of a European collapse.
Europe is China's biggest export market, accounting for roughly 22% of exports. If the European economy collapses, so do Chinese exports. China's economy is significantly dependent on the success of its exporting companies, many of which already operate on razor-thin margins. A weak Europe means many Chinese export companies could go bust. If China's export sector suffers, domestic demand may shrink, potentially impacting companies like the following:
If China experiences a generalized economic slump (or worse), chances are it will no longer require the basic materials used to produce goods. For many commodities and commodity producers, Chinese demand determines whether prices are rising or falling. A weak Chinese economy could send broad commodity prices down the tubes, impacting exchange traded products like the following:
- iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP)
- iShares Silver Trust (SLV)
- United States Oil Fund LP (USO)
If commodity prices decline, the following commodity producers could also decline:
- Freeport McMoran Copper and Gold Inc (FCX)
- Teck Resources Ltd (TCK)
- Rio Tinto Plc (RIO)
- BHP Billiton Ltd (BHP)
Finally, if demand for commodities decline, the exports out of commodity producing countries could fall. If resource demand drops, commodity producing countries like Canada and Australia could see their currencies fall relative to commodity consuming nations. Currency ETFs, such as the following, could be impacted:
Bottom line: A Greek default could have a significant ripple effect throughout the global economy, far beyond what many investors anticipate. Investors looking to explore ways to profit from a potential Greek default may want to consider some of the less anticipated effects, as much of the risk is likely already baked into the obvious investment choices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.