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How to Profit From Second Threat to Downgrade France


One of the troubling aspects of the two downgrade warnings that France received this week is that they were for different scenarios.

France was warned for the second time this week by a major credit rating agency that its valuable triple-A credit rating could be downgraded in the near future.

Standard & Poor's was the latest credit rating agency to say that the eurozone's second biggest economy was in danger of being downgraded. Standard & Poor's said that it would probably downgrade France's credit rating two notches to AA+ down from AAA if either of two scenarios unfolded. France could suffer a downgrade if the eurozone fell into a recession that was accompanied by rising interest rates or if the eurozone experiences a double dip recession.

With so many eurozone members enacting austerity measures to reduce their deficits, both scenarios are becoming more likely. The combination of increased taxes and reduced government spending doesn't bode well for eurozone economies like Greece, Italy and Spain. A Greek default would make matters even worse and just the possibility of a Greek default has led to many major European banks having difficulty obtaining short term financing.

European banks' short term funding problem was a factor in another warning to France earlier this week from Moody's Investors Service. European leaders have been under pressure to come up with a concrete plan to recapitalize Europe's ailing banks, which are having financing troubles because of their large holdings of the debt of Greece and other troubled eurozone countries. With the likelihood of a Greek default increasing, short term financing has dried up at some banks.

Moody's Investors Service warned earlier this week that if France took part in recapitalizing European banks, it would simply be shifting risk from the banks to taxpayers and risked seeing its credit rating downgraded. Earlier this month, the governments of Belgium, France and Luxembourg had to step in to save the Belgian-French financial institution Dexia SA from financial collapse. The three governments agreed to 90 billion euros in financing guarantees for the troubled bank and the Belgian government said that it would pay 4 billion euros to take over Dexia's Belgian retail banking operations.

One of the troubling aspects of the two downgrade warnings that France has received this week is that they were for different scenarios. Standard & Poor's warning focused on the risk that the eurozone would fall into recession, while Moody's Investors Service focused on the much talked about plan to recapitalize the eurozone banking sector. As the financial situation in the European Union continues to deteriorate, each scenario is more likely. An announcement about the banking recapitalization plan is expected soon after an October 23 meeting of European leaders and could lead to a credit rating downgrade for France.

With two warnings to France in one week, the odds of a French credit rating downgrade are increasing. Many other eurozone members have been put on notice over the last year that their credit ratings were under review and a downgrade usually followed within a few months. At least one of the downgrade risk factors given for this week's warnings to France, recession or banking recapitalization, is likely to take place and there are a number of ways for investors to plan ahead in order to take advantage of the situation.

Asian stocks are very sensitive to any bad news coming out of Europe, so if France is downgraded or Greece defaults, Asian stocks could take a hit. Investors who feel that stocks like Sony (SNE), Taiwan Semiconductor Manufacturing (TSM) and Suntech Power Holdings (STP) could soon be falling because of more bad news from Europe could short them. A large portion of these Asian exporters' revenues comes from trade with the European Union, so if the outlook for Europe becomes even bleaker, these stocks could see their share prices fall.

Investors who feel that Asian stocks could be headed for a fall but prefer to diversify their holdings could buy an ETF like the ProShares UltraShort MSCI Japan (EWV) or the ProShares Ultrashort FTSE China 25 (FXP). Each of these ETFs allows investors to short a wide range of Asian stocks from the representative country.

Other investors might feel that the situation in Europe isn't as dire as the press is making it out to be. Although the eurozone still faces many economic problems, Europe's leader s have shown a willingness to address these problems. If the efforts of European leaders like France's Nicolas Sarkozy and Germany's Angela Merkel prove successful, European stocks could see major gains. Stocks like TMS International (TMS) and Banco Santander (STD) and ETFs like the iShares MSCI Europe Financials (EUFN), the SPDR EURO STOXX 50 (FEZ) and the CurrencyShares Euro Trust (FXE) have a great deal of upside potential if Europe is able to turn things around.

Editor's Note: This content was originally published on by Daniel James Hayden IV.

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No positions in stocks mentioned.

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