Be Cautious Of EU Optimism

Includes: DRR, TEF, UUP
by: Investment U

By Jason Jenkins

Remember when the market had a massive gain this summer because there was the thought of a Grand Compromise on the U.S. debt problem between President Obama and Speaker of the House John Boehner? Remember when markets spiked in August when Federal Reserve Chair Ben Bernanke mentioned that the Fed had a “monetary tool-kit” at its disposal. Investors said, “QE3, here we come.”

Now take this all in.

After you digest it, you realize none of this came to pass, but the market right now is just sensitive to any news. And now we see a large market gain on the news, and EU officials are considering the possibility of a significant expansion in the European Financial Stability Facility (EFSF) by leveraging its assets. Investors think the Europeans have finally faced the reality of their sovereign debt problem.

European authorities have also reported the possibility of setting up a special purpose vehicle to buy bonds issued by troubled EU countries. The plan would take EFSF funds to capitalize this vehicle, enabling it to issue bonds and then use the proceeds to buy debt of distressed states.

The investing world loves to believe in the scared-straight notion that the geopolitical world will get it in the end when governments and economies lie on the brink of disaster. But as we have seen lately, that world doesn’t always make sense.

We’ve heard words of encouragement before from Europe, but what has really happened to fix the problem instead of kicking the can down the road?

Note to the EU, your road ends at a cliff in a very few meters …

An Exuberant Market Misses Eurozone Headlines

In all its exuberance, here is what the market has missed the last few days:

  • The majority of eurozone governments have yet to approve the proposal from this summer to increase the EFSF from 250 billion to 440 billion euros.
  • On top of that, the issue of bolstering the EFSF may come at an inopportune time for German Chancellor Merkel who is attempting to gather support for the initial EFSF proposal ahead of a parliamentary vote this week amid resistance from within her own coalition.
  • Many EU officials have stated their commitment to developing a coordinated response to all of these problems by early November. However, there is growing concern that this timeline, when the leaders of major economies are scheduled to gather at a Group of 20-summit meeting in France, may not be soon enough.
  • And of course, you have to trust Greece in all this. Even though they haven’t in the past followed through on all of their austerity measures, you have to believe it’s different this time.

How to Play Eurozone Skepticism

For the past few months, we said that the best plays against the Eurozone crisis were Market Vectors Double Short Euro ETN (NYSEARCA:DRR) and PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP).

As a value play, we’ve also recommended beaten-down European stock Telefonica (NYSE:TEF), the biggest telephone company in Spain and the largest wireless provider in Britain. The fall of the euro most likely will not affect Telefonica’s business because roughly 60 percent of it is coming from growing Latin American markets.

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