Portugal crisis: two ways to play it

Portugal’s economy is in deep recession and its government is on the verge of collapse. But amid the chaos, there are opportunities for investors, says Matthew Partridge.


Unemployment is running at 18%

Summer is traditionally a quiet time for markets. Traders and politicians are on holiday, so there are generally fewer opportunities for meddling and panic-mongering.

But since the eurozone began its slow-motion meltdown, each summer has been tinged by concern. Will Greece need another bail-out? Will the threat of austerity get too much for the Spanish or the Italians?

This year, the big threat may come from one of the quieter troubled countries Portugal. While many Europeans head for the beach, politicians in Lisbon will be meeting behind close doors.

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The coalition that has kept Portugal in the eurozone is close to collapse. Investors are already starting to fret. Bond yields have already surged to above 7%.

So far, European Central Bank boss Mario Draghi has relied on little more than nods and winks to keep markets calm. But that may not be enough. And that could spell opportunity for investors, believe it or not

Portugal's downward economic spiral

As my colleague John Stepek noted a couple of weeks ago, in one sense, Portugal has been one of the success' stories of austerity. Portugal was among the eurozone countries bailed out in 2011, in return for promises that it would make spending cuts.

Early last year, that all looked under threat, when Greece threatened to leave the euro. This not only sent Greek bond yields soaring, it did the same for other troubled eurozone countries. Investors thought they would be a stampede for the exit.

Portugal was among those whose debt was downgraded to junk status by credit ratings agencies. Its bond yields spiked to nearly 18%.

But in the end, Greece stuck with the euro. At the same time, ECB head Mario Draghi said he would do whatever it took to save the euro. Investors backed off, assuming he'd print money to buy bonds, and the eurozone was saved'.

Meanwhile, the coalition governing Portugal was able to agree large cuts in spending and tax rises. As a result, by last November, Portugal's cost of borrowing over ten years had fallen to below 5% for the first time since 2009.

So far, so good. Trouble is, while the spending cuts might have kept Portugal in the single currency, they haven't done the economy sclerotic and public-sector dependent at the best of times - any good. The country is in the midst of a brutal recession, with real (after-inflation) GDP expected to shrink by at least 2.5% this year.

Unemployment is also a major problem. Not only is the overall rate 18%, youth unemployment is above 40%. Many of the most skilled workers are simply choosing to leave, with nearly a quarter of a million emigrating over the past two years. Most are going to other European Union countries. Latin America is another destination, as is former Portuguese colony Angola.

You could argue that this isn't necessarily a bad thing. Some economists argue that imbalances between countries would be reduced much more quickly if more people crossed borders in search of work.

But while movement of labour might be a net positive for the world as a whole, this brain drain' of skilled employees won't help Portugal's economy at all.

Now Portugal's problems run an awful lot deeper than a few spending cuts. Bureaucracy, low accountability the country needs wholesale reform. But austerity is the obvious factor to blame, so that's been the target of the backlash.

Portugal's government is on the verge of collapse

The ruling coalition that has implemented the cuts has seen its popularity plummet. It now lags well behind the anti-cuts Socialist party in opinion polls. As a result, the parties that make up the government are getting tetchy with one another. And since John wrote about it earlier this month, things have got worse.

Earlier this month, the foreign minister resigned, saying he couldn't continue to support austerity. This was a major blow, as he is also a party leader, which threw the future of the coalition into doubt.

At first, it looked as though a deal could be reached, by promoting the foreign minister to deputy prime minister. But then Portugal's president intervened, and said he'd dissolve parliament unless a new government was formed that includes the Socialists.

Of course, the problem is that the Socialists oppose austerity. They would also benefit from the collapse of the government, because that would mean new elections. And so they've refused to join the coalition.

This raises the danger that the anti-austerity Socialists could end up coming to power. If that happens, they are likely to demand that the terms of the original 2011 loan be changed, setting up a confrontation with Brussels and bondholders.

Talks are still taking place, so a solution could still be found. However, it's hard to see how Lisbon could escape the need for a second bailout in any case. That's because the cost of bailing out its banking system means Portugal is likely to miss its deficit targets. That in turn means it could have trouble refinancing government debt which is due to mature in September.

The timing is awful. Germany's elections are in September. So the last thing Angela Merkel wants is to go into a vote with a prickly German electorate, having agreed another bail-out deal.

You can rely on the eurocrats to cover their backs

But if there's one thing the crisis has taught us so far, it's that it's a bad idea to bet against the ability of the eurocracy to find a solution that will fudge things enough to satisfy both markets and politicians and keep the euro project on the road without solving the underlying problem.

This suggests that the ECB will perform a backdoor bail-out by printing money to buy Portuguese bonds if necessary. In turn, that will buoy up any panic-hit eurozone stock markets.

You could buy any of the eurozone exchange-traded funds (ETF) we've mentioned in the past to benefit, or you could opt for an ETF that tracks the Portuguese market specifically.

An even better option for those with an appetite for risk if you have a broker who allows you to buy Portuguese stocks is pulp company Altri (LIS: ALTR). This is a risky bet, and I wouldn't stake too much on it. But trading at a price/earnings ratio of only 5.5, and exporting 90% of its products, Altri should benefit from the weaker euro that money printing would produce.

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri