Decoupling in the stock market is a concept that has been mostly forgotten by investors as the theory did not stand very well in the financial crisis. However, that is a misleading conclusion in my opinion, as there are some fundamental differences between the financial relations between the US and China and the US and the Eurozone. It was kind of naive to assume that China or the other emerging Asian markets could decouple from the US markets. The reason is those emerging Asian economies were mostly dependent on the ability and know-how of US financial institutions to fund their developments.
Simply put, there were some services that the American investment institutions like Goldman Sachs (GS) provided that native financial institutions in the emerging Asian markets could not. Yes, many of those advanced financial services were related to exotic financing schemes that caused the crisis itself, but those very financial instruments were essential to the financing of the huge infrastructure projects in the emerging Asian economies. Therefore, if the American financial institutions were in trouble, so were the economies of emerging Asian countries.
Also, many of the companies that undertook the huge infrastructure developments in China were American engineering companies. That also proved to be another reason why the ties between China and US could not have been broken in the crisis.
Such is not the relation between the Eurozone and the US, however. Eurozone's fundamental engineering and financial institutions are self-sufficient. For example, if they need an exotic financing scheme to fund a huge infrastructure project, they do not need to hire Goldman Sachs to do it. Eurozone financial institutions are more than capable of providing the same sophisticated service. Similarly, for engineering know-how they are not dependent on American engineering companies. German engineering giant Siemens (SI) is more than capable of doing the complex engineering.
Another factor is Eurozone's financial system is mostly funded in euros (FXE). They also issue their bonds in Euros too. The international trade within the Eurozone is also conducted in euros so they do not need the American institutions for trade finance either.
In my opinion, these reasons indicate that European financial system, as well as their infrastructure build out, is mostly internalized. Eurozone has not intervened with the US as much as most investors assume. When that fact is realized by the investors, decoupling might happen. That would lead to some very profitable market neutral trading opportunities to take advantage of the Eurozone crisis.
So what are these trading opportunities in the Eurozone crisis?
Trying to predict when the ECB will intervene in the Eurozone crisis with another LTRO to solve the problem is a losing trading strategy, in my opinion. Mario Draghi is infamous for unpredictability. Of course, for investors who are able to predict the moves of ECB, there are a lot of profits to be made in trading the euro. However, the chances of getting that prediction right is rather low, in my opinion. Also, since this might turn into a very large liquidity crisis if the ECB can't act expeditiously, there is the possibility of some very large losses in trading the euro. Simply put, risks don't justify the returns fro trying to trade the ECB moves.
Rather than trying to predict Mr. Draghi's plans, a more profitable trading strategy is to use a market neutral one, in my opinion. Here is the strategy:
Even if the ECB intervenes and provides another liquidity operation, there is no doubt that Eurozone will go through a fundamentally stagnant phase, as well as growth goes. However, due to the reasons stated above, that stagnant phase will probably be contained in the Eurozone.
In such a case, the US might go through with reasonable growth once the strain on the European financial institutions is eased, while the Eurozone stagnates despite avoiding a liquidity crisis.
A trade to take advantage of such an environment would be to short the German engineering giant Siemens and go long the American engineering giants Emerson Electric (EMR) and Eaton (ETN). Such a trade would be relatively market neutral and protect the investors from fluctuations in the markets due to liquidity shortages. However, as the reasons for European decoupling become obvious, the trade should start to be profitable even if markets deteriorate significantly. I expect this trade to make about a 20% profit in 6 months. Since it is market neutral investors can also use some leverage up to 3X to take their profit potential to 60% without incurring too much risk.
As a separate disclosure, I have received some private messages in response to some of my trading suggestions, asking for more specific advice. I am hesitant to do that because I am not a RIA in the US. However, investors who find my analyses and trading suggestions of good quality can use the "Follow" feature on SA. Most of my trading suggestions will be posted in my articles anyway. So that is the more efficient way.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
