Considering S&P downgraded nine European countries last Friday, markets on the Continent have stayed stubbornly positive. The euro has bounced of its lows and European stock markets are trading higher than they were before the downgrades.
Even as European officials descend on Athens today to negotiate with the Greek government on its debt, it feels like investors have simply hit the point of crisis fatigue. With the annualized yield on a €14.5 billion Greek bond maturing in March hitting a high of 715% on Monday, Greek default already appears to be a fait accompli.
The news from Greece continues to be lousy. The economy is doing far worse than expected. GDP appears to have shrunk by more than 6% in 2011. Only six months ago the projection was 3.8%. Greek banks now need €40 billion to recapitalize because Greeks have been taking their euros to safer, probably colder climes. That compares with an estimate of €26 billion a few months ago.
Investors are now heading for the exits. A Greek default is not really a question of "if" or even "when." The only real question is whether the default will be orderly.
Negotiations this week targeting a voluntary default for a minimum of €100 billion will be fought tooth and nail by everyone from European banks to high-profile hedge funds with skin in the game. A hard default would be worse as even the European Central Bank would be forced to take losses on its own €45 billion exposure to Greek bonds. And you have to wonder, what the point of it all is. Even if it met all its fiscal targets, Greece would only cut its debts to Italy's level today by 2020. Something's got to give.
Right now I'm ready to throw in the towel and assume the worst case scenario, and that Greece does a hard default.
But here's how you can profit.
Short the euro. The euro has already dropped like a rock since early November. Measured by purchasing power parity, the euro is just about fairly valued for the first time in a long, long while.
Some argue the euro would soar with weaker members exiting it, turning it into something resembling the Swiss franc. Over the medium term, I agree.
But I have no doubt that the day Greece defaults, the euro would be hit and hit hard. I've called this the euro's George Soros moment, recalling the time the British pound exited from the European Exchange Rate Mechanism on Sept. 16, 1992.
Options on ProShares UltraShort Euro (EUO) will soar the day Greek defaults.
Short Greek banks. Frankly, I'm eating crow here. A year ago, I thought that Greek banks would pull through. And I am currently still long on National Bank of Greece (NBG). That said, I have my position hedged with put options, which has limited my downside. But overall, I have lost money on this position.
Here's why I now think its time to close my long position in NBG, and bet the other way.
In the case of a hard Greek default, the value of the government-guaranteed bonds that Greek banks have been using to access ECB liquidity facilities would become worthless and no longer eligible as collateral. And the ECB can only deal with solvent institutions. So, all Greek banks would lose access to the ECB as source of funding. That means it's game over for National Bank of Greece and all other Greek banks.
Buy long-term put options on National Bank of Greece and bet on the Greek Banking sector going bust.