How to Trade Moody's Downgrade of Portugal's Debt (PT, VGK, UPV, EPV)

In what is sure to be yet another blow to investor confidence, Moody's Investors Service downgraded the long-term credit rating of Portugal's government bonds two levels from the previous rating of A1 down to the new rating of A3. Along with the lower rating, Moody's gave Portugal a negative outlook, which means that more downgrades could be on the way.

The timing of the rate cut is especially bad, coming just a week after Moody's Investors Service downgraded the debt rating of Greece three levels and downgraded the debt rating of Spain one level.

Last week's series of eurozone sovereign debt downgrades was capped by the devastating earthquake and tsunami that have wreaked havoc on the Japanese economy and stock markets around the world.

Moody's proceeded with the downgrade despite reforms that Portugal recently announced. Like the other eurozone countries that have seen their borrowing costs rise due to concerns over their large budget deficits, Portugal promised to reduce spending and raise taxes.

The eurozone's finance ministers also announced earlier that they had agreed in principle to a set of reforms aimed at boosting investor confidence and increasing the competitiveness of European Union member economies. An important aspect of the new measures is that they will make the punishment of countries who break the EU's budget rules more automatic and less prone to political maneuvering.

However, the response of Moody's was similar to its response to previous promises of reform coming from the Greek and Spanish governments. Promising reform and seeing it through are two different things and Moody's feels that each of the eurozone governments that have announced reforms may not be able to stick to them.

Last year after Greece announced structural reforms, its citizens engaged in massive riots that soon turned deadly. Although the other countries that have announced structural reforms similar to those of Greece haven't seen large scale disruptions like the Greek riots, they have faced a great deal of internal opposition, which is one of the main reasons Moody's has warned that there is a risk that the governments won't be able to stick to the unpopular spending cuts and tax increases.

Moody's also pointed to Portugal's slow growth rate as a reason for the downgrade, saying that Portugal could face “subdued” growth for quite some time.

Despite assurances from the government that Portugal will not need a bailout like Greece and Ireland did last year, it's looking more likely that Portugal may be forced into seek a bailout if it cannot implement reforms and lower its borrowing costs by improving investor confidence.

If Portugal's economic fortunes improve, Portugal Telecom SGPS, S.A. PT is a telecommunications company that could directly benefit.

If Portugal, Greece and Spain are able to get their budgets under control and lower their fiscal deficits without resorting to bailouts, the Vanguard MSCI European ETF VGK is an investment that could do well.

Investors who feel that it's highly likely that the eurozone governments will get past their current fiscal problems may want to take a close look at the ProShares Ultra MSCI Europe UPV, which seeks daily investment results, before fees and expenses, that correspond to twice the daily performance of the MSCI Europe Index.

However, investors who think that that these countries face to many problems, such as rating downgrades, slow growth and economic uncertainty, may want to take a look at the ProShares UltraShort MSCI Europe ETF EPV, which seeks daily investment results, before fees and expenses, that correspond to twice the inverse of the daily performance of the MSCI Europe Index.