To Europe’s leaders and Greek voters, here’s a modest request: Will you please flip over all the cards and make the bold moves that markets are increasingly expecting? At this point, providing further bailout funds for Greece is simply foolish. No amount of money can turn this economy around as long as it’s still tied to the euro and undergoing deep austerity measures. Nearly a year ago, I suggested that the ultimate cure for the country and the continent was a Greek exit from the euro and a return to the drachma as the country’s currency. I still think that’s the case, and the pressure is getting a lot tougher.

Over the weekend, media reports were circulating that such a move may be unavoidable, though it remains taboo for policy leaders to speak of such an event. In the latest issue of The Economist, an unnamed European banker said leading financial institutions are already formulating plans to handle Greece’s euro departure (and possible major bond default). Leading banks have quietly cut a lot of their exposure to Greece in recent quarters, so any fallout on the broader financial system will be more palatable than it was a year ago. Still, there are major concerns that unanticipated ripple effects will at least temporarily destabilize financial markets. That’s why many investors are in sell mode right now. Since hitting a 52-week high on April 2, the S&P 500 has dropped nearly 5%.

#-ad_banner-#Indeed, Greece may take a turn for the worse about a month from now. That’s when the remaining half of the $70 billion in promised funds is set to be transferred to Greek banks to keep them solvent. But Greek voters, in their failure to elect a government that will adhere to the agreed-upon austerity plan, may unwittingly prevent these funds from being disbursed. “This could lead to a run on Greek banks,” warn analysts at Credit Suisse. In my view, this could quickly hasten Greece’s exit from the euro. A Greek default could spread to neighboring troubled economies such as Spain and Portugal, the analysts add.

The good news: When that wave of selling is complete, the market will be freshly-positioned for solid multi-year gains. Position yourself with ample reserve cash for this great buying opportunity to come.

The calendar shifts
Europe’s woes are surely starting to have an effect worldwide. Key trading partners such as China, Brazil and the United States are noting signs of falling exports to Europe and, as a result, all are likely to see gross domestic product forecasts trimmed a bit in the months ahead.

Here in the United States, another dynamic is playing out. Right around mid-year, many investors stop focusing on what corporate sales and profits will look like in the current year and shift their sights to the following year. One recent report says investors may be quite disappointed in what lies ahead. If the report proves true, then stocks could take a hit, at which point more far-sighted investors have a chance to snap up bargains for what is likely to be much more solid economic activity in 2014 and 2015.

Morgan Stanley’s May 10 report entitled “13 Reasons why 2013 EPS Estimates are Too High,” calls into question the near and mid-term economic outlook. Rather than focus on earnings forecasts for individual companies (known as bottom-up analysis), the firm uses a basket of 33 factors that have historically been a solid predictor of economic of profit-margin trends to come. The SWEEP (sector-weighted equity earnings predictor) test finds aggregated profits for the S&P 500 may be just $98 a share in 2013. To put that in context, Morgan Stanley’s individual stock analysts, who examine the prospects for individual companies, came up with a $120 profit target for the S&P 500. That’s a huge gap. Even if the truth lies somewhere in between, it tells you that a number of companies will likely face rising struggles for profit growth.

How does that SWEEP analysis actually work? Let’s take the materials sector as an example. The system looks at inputs such as gold prices, non-farm payrolls, credit spreads and the University of Michigan Consumer Sentiment Index to take the pulse of projected activity in the sector a year from now. And according to these data, it may be impossible for companies in the materials sector to meet current 2013 profit forecasts.

Morgan Stanley’s analysts go a step further and conclude that $98 a share in 2013 S&P 500 profits means the index could slide to just 1,167 by year-end.  This represents a 13% drop from current levels.

 Here’s where I think they might be wrong: The troubles in Greece or the rising awareness that 2013 profits may disappoint could get us closer to that 1,167 level well before year-end. So you should be prepared to pivot into an aggressive buying mode if the market stumbles badly in the next few months. Indeed, a sharp sell-off may lead the Federal Reserve to put QE3 (a third round of “quantitative easing”) into place, which would likely trigger a solid rebound in stocks as investors welcome the liquidity that bond-buying program brings.

Risks to Consider: As an upside risk, corporate profits were stronger in the first quarter than many expected, so predictions of profit pressures may never come to pass.

Action to Take –> This is not a call to stop buying stocks. Indeed, solid bargains are being uncovered every day. So it pays to continue to find appealing stock ideas, but it pays to hedge your portfolio. For example, in my $100,000 Real-Money Portfolio, I own 600 shares of the Direxion Daily Small Cap Bear 3X ETF (NYSE: TZA), which moves at three times the pace of the Russell 2000 Index — in the opposite direction. Many investors also use the ProShares UltraShort S&P 500 (NYSE: SDS) as a hedging tool.

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