Portugal Shakiness Puts Markets On Alert

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Portugal's government on Sunday put an end to concerns that an internal political crisis would lead to a shake-up in the country's leadership, and ultimately threaten Portugal's ability to keep its fiscal reforms on track. That's the good news, but it doesn't necessarily mean one of Europe's most troubled nations will be able to get the economy rolling without further help.

The country has been dealing with political instability and infighting at a time when it needs to deliver serious economic reforms and austerity measures if it's to meet its obligations with the European Union and the International Monetary Fund-all part of a bailout deal that goes through 2014.

Sunday was a victory for Portugal's President Anibal Cavaco Silva, who managed to avoid an early election following major resignations, and instead is keeping the current coalition government in place until the end of its 2015 term.

The continuity in the government mandate there should help the country complete its bailout plan, and it has certainly fueled a general sense that perceived risk of an economic derailment in Portugal has subsided for now.

That small victory allowed Portuguese bond yields to drop Monday more than 1 percentage point from early July, with benchmark 10-year yields sliding to 6.29 percent from nearly 8 percent in recent weeks. Yields drop when bond prices rise.

There's no ETF in the market today that focuses exclusively on Portuguese equities or debt, but exposure to Portugal can be found in diversified pools of European assets such as the WisdomTree Europe Hedged Equity Fund (NYSEArca:HEDJ), which allocates slightly more than 1 percent of its portfolio to Portuguese equities.

The fund's rising success this year speaks to investors' growing interest in tapping into European equities despite what seems like trouble brewing in the region. The $365 million WisdomTree ETF launched in late 2009 has tacked on gains of 5.5 percent year-to-date amid net inflows of $325 million in the period.

'It has been a losing proposition to bet against the Eurocracy,' Hahn Investments' Tyler Mordy told IndexUniverse. 'They have an uncanny ability to keep the euro stitched together, even if it looks a little ragged at times.'

That 'stitching together' has always meant monetary solutions such as printing money to buy troubled sovereign bonds, Mordy added.

'Note that this does note solve the underlying structural problems, which would require debt restructuring and some form of break-up,' he said. 'The key point is that monetary solutions always express themselves most aggressively through the stock market, and not necessarily bond markets.'

'We have witnessed big rallies every time the monetary engines fire up,' Mordy said. 'I don't think that changes for some time. Rolling crises and tactical stock market exposures will be key.'

Shaky Status Quo

In a broader sense, Portugal, like other economically troubled nations in Europe such as Spain and Italy, has a lot riding on its ability to keep its political problems in check.

Political infighting and deteriorating political credibility hinder the government's ability to continue imposing painful austerity measures on a population tired of high unemployment, spending cuts and overall difficult economic times.

If Portugal's leadership can't deliver on its bailout commitment, it might very well need another intervention later in 2014, signaling that the health of the overall eurozone economy might not be as good as some had hoped, some say.

"The Portuguese are becoming increasingly tired of the spending cuts and tax hikes applied by the government," Adriano Bosoni, Europe analyst for think tank Stratfor, said in a webcast. "Portugal is in recession and its economy contracted 3.2 percent last year, its sharpest downturn in decades."

Portugal's unemployment remains the third-largest in Europe, clocking in at 17.6 percent in May, only smaller than Spain's and Greece's in the European Union, Bosoni said.

Yet, as Bosoni put it, while Portugal's instability is clearly a problem, the country still has "some breathing room" before the crisis becomes dangerous for the rest of the eurozone.

The European Central Bank's promise of intervention in debt markets has so far worked to keep bond yields relatively quiet in Portugal, Bosoni said, but the country needs those yields to drop further if it's to rely on bond sales once its bailout program ends in the second half of 2014.

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This article appears in: Investing , ETFs

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