NEW YORK (TheStreet) -- The exposure of Europe's bad debts has damaged the reputation of the euro and opens the door for much greater losses if one of the larger economies, such as Spain or Italy, succumbs in a manner similar to Greece.
An announced bailout deal for Greece (in the form of bilateral loans) failed to spur an immediate euro rally, even after the German cabinet approved the deal. Previous bailout announcements spurred rallies that eventually turned back into pumpkins, and it's likely that investors have finally learned their lesson. Unless the Germans pass the bailout, there will be no bailout.
On that score,
Frankfurter Allgemeine Zeitung
has presented some conflicting opinions. On the one hand, the leadership of the German government is pushing forward with the deal, which should be voted on by Friday. However, the vote may not be an easy one, with the Social Democratic Party (SPD) looking for a transaction tax. Chancellor Angela Merkel, of the Christian Democrats (CDU) doesn't need the votes of the SPD, but she would like their support on such a major piece of legislation.
's cover shows a euro flag matchbook burning and a headline that says the continent is on the road to bankruptcy. German public opinion remains opposed to bailouts, and Merkel's position may cost her in this weekend's regional election.
Passage of the bailout seems very likely, but investors should be prepared that, in the unlikely event that the German government votes down the bailout, the euro could head into a tailspin. Even after the bailout passes, the euro may not rally right away.
There will be a constitutional challenge. Four professors have their paperwork prepared. The chances that they will win are also slim. Merkel claims that this is aid to save the euro, not Greece. Additionally, the vote is voluntary. It is likely that the bailout will pass this hurdle, and only then will the markets breathe a sigh of relief.
Don't expect a euro rally versus the U.S. dollar to turn into a bull market, however. While a short-term pop may be due, this will probably just interrupt the long-term weakening in the euro. The U.S. dollar weakened following the
's announcement of quantitative easing in 2009, designed to aid the mortgage market and banking system. Europe's aid package is far smaller, but the looming threat is large, with Spain as the greatest risk.
Along with the bailout are calls for a European rating agency. The Europeans are upset that the American rating agencies cut the credit ratings of Greece, Spain and Portugal in the midst of the crisis. Except, rather than blaming the American firms for being late with their ratings, rendering them essentially worthless, they blame them for causing the problem. If the Europeans think a rose by another name is not a rose, there will surely be another crisis.
For ETF investors, here's how to play the situation. Use any rally to exit eurozone ETFs.
iShares MSCI EMU Index
and the suite of eurozone country ETFs such as
iShares MSCI Spain
. A rally could be quite powerful in stocks, and short-term traders may try to play it, but investors should take it as a gift if they're underwater in Europe ETFs.
Investors looking for a currency play can wait for a rally before entering or adding to positions in
PowerShares DB U.S. Dollar Index Bullish Fund
. More aggressive investors may prefer
ProShares UltraShort Euro
Gold is likely to fall if investors become relaxed after the deal is approved. Fear helped push the metal higher even as the U.S. dollar gained strength versus the euro; and even if the U.S. dollar weakens versus the euro, gold may still fall in the short run. This may provide a good buying opportunity for long-term investors looking to add to or initiate positions in
SPDR Gold Shares
iShares Comex Gold
Finally, U.S. stocks are likely to benefit. They may underperform European shares during a short-term euro-fueled rally, but they will also rise as fear exits the market. Also, the U.S. benefits from the fact that confidence in Europe has been shaken. Relatively speaking, the U.S. still looks better today than it did six or eight months ago. Solid dividend paying companies found in
iShares Dow Jones Select Dividend Index
, or tech firms found in
, should do well.
The Greek debt crisis may be solved for now if the aid package is approved, but it would be incorrect to view this as the end of Europe's problems. In the near term, markets may respond positively, but in the intermediate to long term, there are likely to be more problems. Europe is not out of the woods yet.
-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion was long iShares Comex Gold, iShares Dow Jones Select Dividend Index and PowerShares QQQ.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.