Investors are calling this risk “Lehman Squared”

As Eurozone turmoil resurfaces, Gemma Godfrey takes you through the under the radar risks and how to trade them.

The risk of Greece leaving the Euro is looming large over markets as a ‘snap’ election nears on Jan 25th. Threatening to reverse the austerity measures (spending cuts etc) required for bailout funds and remaining in the Eurozone, Syriza looks likely to lead any coalition government, if it does not win outright.

Feared it could be “Lehman Squared” (have a larger effect on markets than the collapse of Lehman Brothers), a Greek exit could be catastrophic. The country would be shunned from international markets, with a new/old currency that would devalue so severely that capital controls could be required and a make run on banks inescapable. It could be disastrous for an economy which is already contracting and struggling with high unemployment.

Nevertheless, the bigger risk for investors is that the turmoil spreads to larger neighbouring countries

Why then do the markets appear sanguine? The Italian government succeeded in refinancing €3 billion of sovereign debt at its lowest rate on record. Moreover, even the yield on Greek bonds remains far below historic highs.

The reason is that the following risks have not been widely recognised.

Investors are underestimating the possibility that the anti-austerity movement could gather momentum through the region. With elections due in Portugal and Spain, the Greek election results could spark resistance in larger economies.

Furthermore, there is a misplaced belief that the ECB has enough firepower to contain any turmoil from spreading. This is questionable and unproven.

Nevertheless, Greece is unlikely to give away the golden goose so quickly – the threat of leaving the Eurozone is the one bargaining chip they have. Therefore, the more likely outcome is they will continue with austerity, albeit to a lesser extent, which they can claim as a win.

Therefore, as the election nears and risks come to light, weakness in the shares of high quality international Spanish and Italian companies could provide attractive entry points. While the risk/reward trade-off in Greece remains unattractive.

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