BigTrends

There's been a clear asset allocation into securities such as Government Bonds (TLT) and Gold (GLD) as investors & traders look for safe harbors in this uncertain economic environment.  With less attention, however, the Japanese Yen has gained significant ground versus both the Dollar and the Euro.  Take a look at the chart below, which tracks Dollar/Yen forex (USDJPY) and Euro/Yen (EURJPY).  You can also utilize FXY etf for tracking the Yen.

Dollar/Yen and Dollar/Euro Chart


First, you can see that the decline of Dollar and Euro vis-a-vis Yen has basically been in tandem -- indicating a clear safety preference for the Asian currency.  Also note the big decline in late '08/early '09 -- this was in line market weakness -- however, there was not a corresponding selloff in March '09 when the market panic bottom of SPX 666 occurred.  This was a sign that the stock selloff was overdone.

Another factor to consider is that Euro and Dollar have actually breached to new lows below the 2008/09 levels ... meanwhile the stock market is far above those levels -- even if you throw out the 666 bottom, we're still fairly high above the 800/900 SPX levels reached in late 2008/early 2009.  If the market follows suit, keep an eye if SPX 1000 is breached in the coming days, we may then go as low as SPX 900 (881 is also a Fibonacci level) in September.  At that point, we may then see a strong market rally as mid-term elections approach/occur -- but that's for another article.

One of the key indicators I'm watching in this market is the Euro (in addition to bonds TLT, discussed here).  I prefer to use the CurrencyShares Euro Trust (FXE) because it it is very liquid in both the underlying and its options.

The key here is that many hedge funds and institutions have "short Euro" plays on.  When/if these begin to unwind or get reversed to the upside, we will see Euro buying and selling in assets such as Gold.

Recently the FXE has shown signs of life, see the chart below.

FXE Daily Chart


You can see the downtrend in place on the Daily chart since December 2009.  However, we see some indications that the bounce in the Euro may have some legs.  Percent R has crossed into clear bullish territory above 80 for the first time in this downtrend.  Also, we are now 2 trading days above the 40 day exponential moving average (purple line).  Previous rally attempts failed at this trendline and reversed lower, with a 1 day blip above in April.  Closing above that ma today should be considered a confirmation, and the 40 day and 20 day exp moving averages should now act as support on pullbacks.  They lie around 124 and 123 currently.

George Soros, the famed trader/philanthropist/muckraker, said during a speech in Berlin that the Euro currency and in fact the European Union (EU) may be in danger.  He basically attributed Germany's economic tightening policy and unwillingness to bail out fellow European countries as a possible cause of a breakdown.

Soros is an interesting  and polarizing character -- raised in Nazi-occupied Hungary, he then became of the world's most famous and rich traders (known for "breaking the bank of England" in 1992), and in recent years has leaned to becoming a strange mix of libertarian/socialist/pacifist activist that has confronted many world leaders and governments.  Many Americans don't like the very opinionated politically-oriented pronouncements that come from Soros in recent years.  But the complex nature of his beliefs can be seen by the fact that in the 1970s he garnered huge profits in a hedge fund with Jimmy Rogers, who is a vocal free market, limited government spending advocate.

This attack on German fiscal policies by Soros is a bit complicated, as is the entire worldwide Debt and Currency Crisis.  But he basically seems to be saying that Germany should be increasing public spending in order to stabilize Europe and keep economies from slipping off the brink.  And to some degree he may be correct in the short-term, as massive spending in America has helped to temper our recession (long-term effects are a different story).

However, by bringing in the concept of Euro/EU failure and saying "Democracy itself could be at risk", he basically is raising panic and fear -- and not in a responsible manner in my view.  I would assume he is doing this for political reasons, not personal trading/financial ones -- but he can shake world markets with talk like this.

I don't consider myself an expert on global macro economic news, but there is an interesting event coming up which may influence the markets quite a bit.  The bi-annual G20 Summit is coming up June 26/27 in Toronto.  We've heard rumblings about European bankers working on their growing debt and currency problems (Hungary is the latest to be shook).  Also talk about President Obama trying to push through Financial Reform before this meeting.

What I envision is that right before this meeting of Heads of State, European bankers may unveil some sort of large bailout/restructuring type of package.  Whether this package is fiscally good or not or solves problems really isn't the issue here.  What is important is the market's reaction.  And based on how the market has reacted to important news recently, which I would call reacting in an "obvious" fashion after the news breaks -- I would bank that the market would initially rally on this type of announcement.

By "obvious" I mean that we've been seeing a short-term rally on perceived good news and the reverse for bad news.  However, the drumbeat of bad news from all over the world will continue (aftershocks of the global financial crisis will continue, possibly for years).  So after a runup whenever good news comes that may last several days -- be then prepared to put on Short and Put positions, because the technicals and fundamentals indicate that rallies will be reversed back to the downside.

History is often a very good guideline when we enter times of extreme volatility in markets and trading.  Currently, the plight of the EU Currency the Euro has many gnashing their teeth worldwide.  The Euro is making a test of the key 1.20 area versus the U.S. Dollar (see the following chart).

From a technical basis, the Euro certainly could hold this 1.20 level and bounce from here.  However from a longer-term historical basis, there really is nothing wrong if it does break down through this level.  The Euro was basically "pegged" at a 1-to-1 basis with the Dollar at its creation.  Subsequently, it traded in a 0.80 to 1.20 range around the Dollar for several years after -- see the highlighted box below.  This is a logical 20% up/down range above the mean, in my view.

In the years since, we have seen a new extended range for the Euro, roughly 1.20 to 1.60.  However, a breakdown of this newer range and a re-establishment of the previous range (which may well happen) would not be an abnormal, unexpected type of occurrence.  In fact, for those of you who have traveled to Europe from the U.S. during this time, you may agree with me that a sub-1.20 Euro is actually a more "healthy and normal" rate when you look at consumer-type prices.

Euro/USD Monthly Forex Chart

Just wanted to point out that we look to be in one of these negative worldwide news cycles. This makes it very difficult to get comfortable from the long-side perspective. Bad economic/debt news from Europe continues on a steady basis, big concerns about China & Asia are emerging, a giant Oil spill that has been extremely mismanaged from a PR perspective, etc.

When Asia or Europe gets roiled a couple of times a week, this weakness then spreads to the U.S. morning action -- and the influence of these markets vis-a-vis the U.S. has become more important than ever. It used to be that the United States stock markets almost always dictated the mood in Asia and elsewhere -- but one can plainly see that China is becoming more and more the big player on the block in so many areas.

Bottom line is that the continued bad news is reminiscent of the banking/mortgage crisis we saw here in recent years. However, it is not likely to affect things in such a drastic manner -- and as a matter of fact, the reaction to bad news will be one of the leading voices showing when the market wants to go significantly higher. . But as I mentioned, it makes it very difficult to make strong upside bets -- so the bias for stocks remains to the downside for now.

The dollar remains strong against a weakening euro.   Gold has been soaring ever since the weekend bailout move, reaching new all time highs, dragging silver along with it.  Gold has become a crowded short-term trade, full of momentum and likely to back down very soon.  That doesn't change the argument against gold for a longer term trade, as relative to fiat currencies hard assets are a good place to park.

With the Fed's participation in opening swap lines with the euros, this opens up an eventual deflationary scenario for the greenback.  How so?  Basically, the Fed is allowing the euro countries to swap their currency for dollars, which will pound the euro (already working).  The dollar is still inflated vs the euro and others of course.  This is a shorter term stimulus to the euro countries, being able to swap a weaker currency for stronger dollars.  These swap lines generally have terms of 60 - 90 days.  What happens when those terms are up?  The Fed just prints up more dollar, deflating the greenback...inflationary?  You bet it is, and we'll see hard assets continue to gain value.  This is not a short term problem and will not be solved with silver bullet solutions.  

Did you miss that rally on Monday?  4% move based on the 'shock and awe' from the eurozone.  A trillion dollars...imagine that!  If you were positioned for the rally on Friday then you did well.  Of course, that was a big bet on the euros making this bold statement.  What needs to happen now?  Well, the market may now be rangebound.  I'm not sure a retest of Thursday's low is really necessary and that is probably the low for the year.  Given the stimulus and liquidity it's likely money will be coming into our markets in droves.  In addition, the opening of swap lines between our Fed and the euro will make it easier for the euros to capitalize on a stronger greenback. 

Did the euros panic?  I think they did and probably with the help (push?) from our Fed and Government.  Look, our recovery is on track (or, it was) and the continued waffling back n' forth between the countries has put fear into all markets.  Bailout, no bailout.  Small bailout, large bailout.  Once this gargantuan number was rolled out Sunday right before trading began in Asia the reaction was as expected.  Heck, they are getting ahead of the curve now rather than chasing.  If Portugal fails, covered.  Spain?  Got your back, Spaniards.  Markets?  Well, a 4% move up after one of the worst weeks in recent memories sends a message to the shorts:  Don't mess with reflation.

The key here is avoiding the D word...Deflation.  The continued worries over inflation by the Euros were misguided, and much like the defensive posture of our Fed in 2007/08 they needed a bold response:  nearly a trillion dollars in 'potential' aid.  Why wouldn't they put this out to 'shock' the markets and the world?  It's yet to be seen if this response is damaging long term, but there is precedent.  Certainly our markets are the model here.  To be continued.