The Euro Is ‘Dead’: Here’s How To Survive

May 18, 2012

It's time to look closely at investment exposure involving the eurozone and the beleagured euro.

The other day I saw a great tweet that summed up the eurozone crisis in one quip: 'The euro is dead. They’re just bickering over who pays for the funeral.'

I don’t believe the euro will disappear, but I do believe there will be some big changes, and ETF investors need to protect themselves accordingly.

Firstly, anyone with European equity exposure needs to stop, analyze and reposition if necessary.

Every week here at IndexUniverse, we update our MSCI Currency Impact Report, and one thing is glaringly clear—the euro’s depreciation has destroyed returns. Never mind the fact that most of the European equities are well in the red in local terms.

For a country like Ireland, which seems to have put its banking crisis in the rearview mirror, the euro has been nothing short of a millstone for Irish equities.

MSCI Ireland Index Total Returns

In the past 12 months, Irish equities have risen 6 percent on a local basis. However, U.S. investors, whose euro-based Irish investments are turned back into dollars when they cash out, have seen returns of -4 percent in that same period due to the euro’s depreciation.

Some may believe that the worst is behind us and that a Greek exit from the eurozone is already priced into the euro’s current value.

I’m sorry, but I’m still skeptical of that analysis.

Greek banks have seen a record amount of deposits being pulled out. To make matters worse, as Greek banks become more dependent on the European Central Bank, the ECB has said it will “temporarily” stop lending to some Greek banks to limit its exposure and risk.

In other words, the ECB seems to be preparing its balance sheet for a Greek exit, and you should too.

Should Greece exit—some are calling it a “Grexit”—the euro will undoubtedly take another brutal hit in the short run.

Luckily, ETF investors with significant European exposure have something at their disposal to ease the pain—the PowerShares DB US Dollar Index Bullish Fund (NYSEArca: UUP).

I’ve had my gripes with UUP regarding the lack of diversity in the fund and how it fails to represent the true value of the dollar on a global scale.

Nearly 60 percent of its portfolio represents a short position in the euro relative to the dollar. However, that’s exactly what makes UUP a great hedging option for those wishing to mitigate the pain from the currency exposure of European equities.

Graph_3

UUP’s price has been relatively steady in the past year—and has even eked out slightly positive returns of 3.06 percent.

The MSCI Europe Index, on which the Vanguard Europe ETF (NYSEArca: VGK) is based, has meanwhile wallowed in the red, losing 16.60 percent over the same period.

The returns VGK and UUP would bring your total returns much would be more in line with the -10 percent that local investors experienced free of the euro head winds.

To be fair, Greece’s impending exit may not be a complete death sentence for the euro. But it would bring more hardship to Greek citizens and may cause them to long for days when austerity measures were the talk of the day.

That’s because if the country were to move toward a reincarnated drachma, inflation would take its toll on citizens’ life savings, and bank runs would only get worse.

The scenes from such an event may serve as a warning to Italy and Spain that the grass on the other side isn’t that much greener.

It’s still too early to tell how all this will play out, but one thing’s for sure, the future is not bright, so prepare accordingly.

 

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