The Euro Action Which Does Not Kill Germany Will Only Make It Stronger

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Includes: DIA, ERO, EWG, FXE, FXY, IWM, QQQ, SPY
by: J Clinton Hill

The intraday spectacle of the Dow’s 1000-point drop and its quick recovery reminded me of Rocky Balboa’s first fight against Apollo Creed. Rocky was pretty beat up and quite bloody, but the SOB stood up and refused to go down. The bulls (or PPT for conspiracy theorists) had @ 348 points carved out of their backsides by the Dow Industrials, but they lost with style.

Oh well... thwarted comeback or not, at the end of the day whip-ass is still whip-ass and, from what I can remember, it still hurts no matter how one spins it. On the other hand, there is Nietzsche espousing that which does not kill us makes us stronger.

With the U.S. Dollar and the VIX attaining new 250-day highs, I anticipate further volatility and maybe even a few killings for good measure, if one is a nimble enough bear or bull. Some very astute traders who I personally know have been short this market used today’s opportunistic plunge to cover and one of them even turned coat and went long.

Personally, I cashed in almost 90% of my chips in mid-March and have been on the sidelines while literally tending to my vegetable garden. I was almost tempted to go long today, but decided not to fight with my trends (or friends for that matter). The short and intermediate term trends for the DJ-30, Nasdaq 100, and Russell 2000 are downward and bearish. Meanwhile, the S&P 500 is barely holding on to its intermediate uptrend and appears to have found support at its 50-week moving average and resistance at its 50 day moving average.

market trends_hb 5-6-2010

Hillbent.com Market Direction Trend Analysis

sp-500 weekly 5-6-2010

S&P 500 Weekly Chart

The breadth of decelerating market momentum has increased. Approximately 86% of stocks are below their 20-day moving average and 70% are below their 50-day moving averages. Unless these numbers improve, the S&P will muddle at best.

Believe it or not, this market is not as oversold as it appears to be. Stochastic readings for the Russell 3000 components indicate a market condition of only 2% overbought and 50% oversold. Typically, one needs to see the oversold breadth percentages approaching the 70’s or 80’s range before a significant reversal occurs.

There’s a whole lot of selling and shaking going on at Wall Street. In terms of price volume analysis (PVA), capitulation selling (price down & volume up) reigned supreme @ 78%. A lot of investors, whether rightfully or wrongfully, were shaken out of their trees and the remarkable intraday recovery makes me suspect that stocks were being transferred from weaker hands. Only time will tell.

Bull markets are supposed to climb walls of worry and this one certainly has its work cut out for it. For further clues, one need look no further than the forex markets and the euro vs. U.S. dollar relationship. Currently, the euro looks like a dead man walking as this sovereign debt crisis has clearly exposed the underbelly of the world’s largest economy and major economic ally of the U.S., the EU, and its potential conflicts of interests amongst its members.

Weekly Chart of EUR/USD Currency Pair

Weekly Chart of EUR/USD Currency Pair

Also, as market participants become more risk averse when the "fit hits the shan," the Japanese Yen typically strengthens (aka the carry trade). The Yen has exploded recently and I would prefer to see it fall back within its downward channel to give some sign that the sovereign debt crisis is being contained. (For purposes of simplification, I have provided a chart of the FXY instead of the USD/JPY currency pair).

Weekly Chart of Japanese Yen ETF (NYSEARCA:<a href='http://seekingalpha.com/symbol/FXY' title='CurrencyShares Japanese Yen Trust ETF'>FXY</a>)

Weekly Chart of Japanese Yen ETF (FXY)

Many are legitimately pondering the viability of the Euro’s survival and the potential for a contagious crisis. While I do not believe that Europe will revert to its dark ages in this lifetime or the next (barring any man-made or natural catastrophes of biblical proportions, of course), I also find myself considering the impact of a weaker euro. One can hardly ignore the interdependent economic relationship between Europe and the U.S.

EU-US Bilateral Trade Summary 2008

EU-US Bilateral Trade Summary 2008 (Source: European Trade Commission)

Still, one needs to step further back and really take a global instead of a regionally international view of the existing U.S. trade relationships. While the Eurozone is important, its U.K. component ranks 5th among the top 5 countries receiving U.S. exports (1st-Canada; 2nd-Mexico; 3rd-Japan; 4th-China). In terms of imports supplied to the U.S., Germany ranks 5th among the top 5 countries (1st-Canada; 2nd-China; 3rd-Mexico; 4th-Japan).

Largest U.S. Trading Partners 2009 (Source: Wikipedia)

Largest U.S. Trading Partners 2009 (Source: Wikipedia)

Given all the above, the biggest beneficiary of a weaker euro will be Germany, which is one of the world’s top exporting economies and home to one of the most productive labor forces in the world. It might be premature to buy Germany at this juncture, but one should monitor its exchange traded fund (EWG) and reconsider a couple recent positive economic reports. Both German Factory Orders (5.00% vs. 1.4% estimates and 0.0% previous) and Manufacturing PMI (61.5 vs. 61.3 estimates and 61.3 previous) indicate an expanding economy but have been overshadowed by the Greek sovereign debt crisis.

Weekly Chart of Germany ETF (NYSEARCA:<a href='http://seekingalpha.com/symbol/EWG' title='iShares MSCI Germany ETF'>EWG</a>)

Weekly Chart of Germany ETF (EWG)

Yes, this too shall pass away. However the biggest spook for the U.S. economy is probably the BP (NYSE:BP) oil spill off the Gulf Coast. I do not have time to get into details on this one. Fortunately, the good folks at ZeroHedge have shared a very insightful report on this topic which I highly recommend reading.

Finally, dear readers, I must bring you back to Nietzsche for in every crisis therein lies opportunity. The euro or demise of it will not kill Germany, but will make it stronger by giving it a more competitive advantage over its eurozone neighbors as well a better footing amongst other global export-based economies or countries.

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