Sage Weekly Letter

US equity markets kicked off the new year with a bang as investors continue to view the US from a “glass is half full” perspective. US economic data continues to impress and chart a generally upward trend, whereas, European economic data is much more uneven with many parts of the eurozone periphery flashing strong signs of recession. The German economy has managed to weather the debt crisis storms with alacrity – The German unemployment rate remains in a steady downtrend while other eurozone members such as Spain can only gaze with envy:

Via WSJ

Even German economic sentiment has had a recent uptick despite a steady downtrend in euro area economic sentiment remaining well in place. The decline in euro exchange rates ($EURUSD, $FXE) has added jet fuel to the German export juggernaut which will only serve to enlarge an already wide economic/fiscal gap between Germany and its euro neighbors.

The recent steep fall in EUR/USD to below the 1.27 level on Friday has been a little surprising given the overwhelming bearish sentiment toward the common currency, and the record speculative net-short position in euro futures:

Markets have an uncanny knack for punishing crowded trades; therefore, the relentless decline in the euro (with hardly any bounce) is a sign that large players simply want out of the currency. Bruce Krasting wrote an interesting blog post wherein he details some of his thoughts on EUR/USD and outlines an option to help the eurozone (EZ) over the near term which I haven’t heard widely mentioned before:

“What is one option that is not now being considered and would have a beneficial affect on the EU? Simple. Devalue the currency by 20%…..A significant devaluation would be a big boost to short-term economic prospects for the EU. It would do little for the solvency/funding problems. But it would stimulate growth and create some jobs. Without that, the EU is dead anyway, so devaluation is not out of the cards.”

Bruce and I have never met but I like him already – He is correct that a 20% devaluation would have a hugely beneficial effect for EZ economic prospects in the short-term. Such a devaluation would be much less painful than other alternatives such as members exiting the EZ or continuing on the insane path of austerity which is sure to plunge most of the EZ into depression.

Perhaps it is this euro devaluation which helps to explain the complete disconnect between US equities ($IWM, $QQQ, $SPY) and EUR/USD:

 

However, such a euro devaluation would have a tremendously negative impact upon the competitiveness of US exports to the eurozone. Any corporation which incurs costs in dollars ($DX_F $UUP) and receives sales revenue in euros ($FXE) would experience a drastic overnight drop in competitiveness. Start compiling your lists of companies which fit this criteria – $F, $GM, $KFT, and $WHR are the first to come to mind.

For the last month investors have enjoyed a respite from major negative eurozone headlines, I expect this respite to come to an end over the coming weeks:

  1. Greece is in dire straights and does not belong in the euro – Will the other EZ members agree to an unlimited series of fiscal transfer payments in order to keep Greece propped up?
  2. Sovereign yields (Italy, Spain, etc.) remain at unsustainably high levels – Hundreds of billions of euros of debt will be issued by financially troubled EZ members over the coming months, I expect these debt sales to be bumpy.
  3. Many EZ member nations (Greece, France, etc.) will hold important elections between now and May – Not much has been made of the fact that Sarkozy is unlikely to be re-elected as French President on April 22nd, and the current front runner Francois Hollande (socialist) has a much different concept of how the EZ should function than the current Merkozy concept.
Technical Structure of the Market

The S&P 500 remains buoyant above its 200-day moving average at the upper end of the 5-month range. There are many positive signs across charts of the major indices and individual equities, however, there are also some bearish divergences worth noting. Moreover, $SPY was unable to surpass its Tuesday morning high despite a raft of positive economic news late in the week. Let’s go to the charts:

$SPX – Looking solid but still in the heart of major resistance – A decisive push above 1300 on strong volume would offer clarity that the uptrend is for real, whereas, a failure to hold above the 200-day SMA (~1260) would be further evidence that the market is still stuck in the wild oscillating range.

$IWM $RUT – The Russell 2000 remains stuck at major resistance.

Individual names such as $CAT and $FCX (cyclical names which can often be leading indicators of economic trends) offer little in the way of clarity in terms of trend:

CAT – Many individual equities are positioned similarly, toward the upper edge of the recent rage with unattractive risk/reward propositions.

$FCX Weekly – Bear pennant/symmetrical triangle

$HYG (high-yield corporate bonds)- Bear engulfing at resistance on the weekly.

$SSEC Weekly – Bearish engulfing candle formed last week – Chinese equities continue to exhibit little in the way of a bounce as Shanghai plumbs fresh mulit-year lows.

The divergences which indicate that US equities have become a bit too exuberant over the near term are growing, I expect the primary divergences (EUR/USD and SSEC) to resolve themselves shortly.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus
Powered by WishList Member - Membership Site Software