The next two dominos?

In the 1950s, US president Dwight D Eisenhower proposed the domino theory regarding the spread of communism in Asia.

Today we could be facing a similar situation in the eurozone, where indebted nations are tipping over domino style, with Germany and the European Central Bank as the backstop.

Already, we have seen Ireland, Portugal, Greece and Italy all forced to their knees and, more recently, questions are being asked of Spain and France.

The eurozone sovereign debt crisis has been developing for a while now and, despite posturing from some eurozone leaders, little seems to have been done to resolve it.

Emergency bail-out packages and bond buy-backs by the European Central Bank (ECB), have been implemented, but a solution? Not as yet.

Germany has, ostensibly, taken the lead. But it remains reluctant to harm its own economy by giving the go-ahead for the ECB to become a lender of last resort over inflation fears.

So, with little reason for optimism in sight, should we prepare for Spain and France to follow in the footsteps of its Mediterranean neighbours (and Ireland)? (FundTalk continues below)

What does this mean for the investor? Which funds hold the biggest exposures to the countries many people are tipping to fall next?

Below we list the funds with the biggest exposures to Spanish debt:

The exposures are relatively, as you can see, quite low. Concerns over the Spanish economy are longstanding, and as a result fund managers have clearly been lowering their Spanish holdings.

The Spanish government was forced to accept a 6.975% yield on 10-year bonds ahead of its elections, sparking further concerns over the economy.

However, exposure is restricted to single digits and is unlikely to prove too much of a detractor from a properly diversified fund.

And France:

As you can see, it’s a bit of a different story. Much higher exposures are evident for France.

However, it is only recently that concerns over France have become more apparent.

Not helped by a rogue ratings downgrade by Standard & Poor’s, which was soon retracted, it has seen yields on government debt rise more recently.

“Ultimately, the domino theory led to the US involvement in Vietnam in what was a costly conflict in every sense”

Thinktank the Lisbon Council says “alarm bells” should be ringing for France, which ranked near the bottom of two surveys with indebted eurozone countries, arguing for significant reforms to safeguard its future.

These tables do not specifically tackle corporate debt exposure, meaning to give an indication instead of government debt holdings. It is often hard to tell how corporates will react to a sovereign debt downgrade or a bail-out; sometimes the effects can be far-reaching, particularly for banks. Other times, perhaps less so.

Ultimately, the domino theory led to the US involvement in Vietnam in what was a costly conflict in every sense.

Supporting the euro against the debt domino effect will also be costly and it will take time for the single currency to re-emerge stronger. Austerity measures, unemployment and political instability, currently confined to the heavily indebted eurozone members, could reach Germany.

If Germany is to continue its assumed leadership in the eurozone, it might find itself dragged into a protracted battle to save the euro and its inflation rate may not be the only victim.