By Jeremy Gaunt, European Investment Correspondent
LONDON, Nov 22 (Reuters) - Dusting off the 1960s analogy of countries falling into communism like tipping dominoes, investors are bracing for the next round in a country-by-country crisis over euro zone debt.
After the Greek bailout earlier this year and the one agreed in principle for Ireland, Portugal is widely cited as the next domino, followed by Spain -- a far larger economy than those yet dealt with and one, that if it did topple, could potentially exhaust the European Union's aid funds.
It is not inevitable, but the chances of the dominoes continuing to tumble are being exacerbated by the large amount of time it will take for countries concerned to get their finances in order and by the fact that investors can make safer yield plays elsewhere.
Because markets are not giving peripheral euro zone governments time to prove their various austerity packages, the mainstream investors whose money is needed are avoiding the sector and looking elsewhere.
Without eager buyers of their debt, the borrowing costs high-debt euro zone countries face will climb yet higher, exacerbating their problems and maybe hastening the point at which they need outside help.
"We would not touch it (peripheral debt) either long or short. It is a very specialised game," said Emiel van den Heligenberg, chief investment officer for global balanced investing at BNP Paribas Investment Partners.
"We feel more comfortable taking credit risk in high yeild corporate bonds via index (credit default swaps) or index funds."
One result is that the European Union's potential 80-90 billion euro financial aid package for Ireland agreed on Sunday has had only a modest impact on peripheral euro zone debt.
The yield spread between German
Some of this may reflect last week's expectations of a deal -- Monday's narrowest spreads were some 100 basis points narrower than a high hit on Nov. 11.
But the run up to the deal and its confirmation have still left Irish-German bond spreads wider than they were at the beginning of November and well above their Greek crisis levels.
Portuguese spreads
The clear implication is that investors do not believe the currency bloc's debt crisis is over, multi-billion euro zone bailouts or not.
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For a graphic on euro zone debt spreads click:
http://r.reuters.com/hyb65p
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SELF-FULFILLING PROPHECY
Investors say what will end the rolling euro zone crisis is a clear sense that the indebted countries are taking the steps needed to bring their finances under control.
The problem is that even when such plans are introduced, markets get jittery at the first sign of trouble. It was not that long ago, for example, that Ireland was getting kudos for the speed and depth with which it was addressing its deficit.
"It is very hard to think that we are out of the woods yet. Results will take time. Markets aren't always the most patient judges," said John Stopford, head of fixed income at Investec Asset Management.
His firm holds no peripheral European debt, even in funds which suggest them as part of a benchmark. Again, Stopford says he can get better, safer deals elsewhere.
So there seems little to stop the crisis now rolling on to Portugal, where figures on Monday showed nearly 14 billion in net portfolio outflows in the first three quarters of this year.
That compared with 6.2 billion euros of net inflows in the same period a year earlier.
Lack of confidence from investors such as this has a way of becoming self-fulfilling. Bond traders at Matrix Securities summed this up in a note on Monday:
"Our concern for Portugal, Spain and Italy is that the market will continue to be wary of refinancing maturing peripheral sovereign debt in 2011, which can result in higher CDS spreads, lower bid-cover ratios, increased refinancing costs, and most importantly, an inability by the sovereign to reduce public debt as a percentage of GDP."
CONTAGION
To date, the European Union and International Monetary Fund have managed with their aid packages to keep the crisis from spreading too quickly and from causing wider global disruption.
The euro, for example, has remained at far higher levels
against the dollar
There also seems little doubt that if a new crisis arose around Portugal that some kind of deal would be done.
But where investors start to get very wary is when it comes to Spain, whose size makes it entirely different from Greece, Ireland and Portugal.
Andrew Bosomworth, an executive vice president with PIMCO Europe in Germany, reckons there may not be enough triple A-rated money in the EU financial aid pot to cover it. (Editing by Mike Peacock)