Trades For The Approaching Euro Strength

by: portfoliV

Let me start by admitting that I have been wrong on the euro (NYSEARCA:FXE). Back in early May of 2012 I posted some trades based on the euro not breaching the $1,29. I certainly did not expect the sell-off in May 2012 to be so severe. I did expect the euro to go toward $1,14 and I did expect a severe correction in the markets later in the summer of 2012, but I certainly did not expect the markets to be so weak in May of 2012. The weakness of the snap-back rally after the sell-off also has surprised me.

However, the recent price action on euro seems to be indicating a short-term bottom as the sell-off has become very steep. Such steep decreases, compared with a gradual but persistent decline usually indicates short-term bottoms. The ECB will also be increasingly forced to intervene in the euro weakness as the market has been non-responsive to other tools. In fact, I would argue that any further weakness in the euro would be followed by an immediate ECB intervention. ECB will be motivated by the fact that other tools have proven to be not useful. Hence, if the ECB does some form of a QE it will be subject to less criticism. Given the troubles of Spain and Italy any ECB intervention would be a nice respite and might be given a free pass without too much scrutiny.

Also, the recent sell-offs in the euro have all been followed by sudden increases to negate the sell-offs. There is also the fact that U.S. 10-year yields are at extremely low levels and any further down movement should prove to be more difficult. Those two reasons make it very likely that euro will put a short-term bottom and once that becomes apparent there might even be a strong short squeeze.

I would argue that some stocks on the market are very much correlated to the euro strength and have failed to go up along with the market in July 2012. Any strength in the euro would cause oversold stocks to experience a nice increase. Hence they are the best way to take advantage of an expected euro strength, in my opinion.

The most obvious example is Morgan Stanley (NYSE:MS). Ever since the euro crisis worsened and started to determine the market sentiment, Morgan Stanley has been singled out as the most exposed to the eurozone troubles. The stock has basically become a leveraged trade on the direction of the euro. It has become way oversold in the euro weakness and it will do some nice catching up once the euro stabilizes, in my opinion.

The other trading opportunity is in Silver (NYSEARCA:SLV). The precious metal has not participated in the rise in market sentiment due to the weakness of the euro. It is another asset that will catch up to the market once the euro stabilizes. Some oversold stocks such as Green Mountain Coffee Roasters (NASDAQ:GMCR), NetApp (NASDAQ:NTAP) and Cree (NASDAQ:CREE) might also benefit greatly from a rise in market sentiment from a stabilized euro.

Investors can also capitalize on the fact that MS and SLV will simply outperform the market if the euro stabilizes. Therefore investors can pair a short position in the market (NYSEARCA:IWM) with a long MS or SLV trade to eliminate any risk of surprise changes in the market sentiment. Such elimination of risk can also make use of leverage possible. I will try to post a follow-up article to this short-term trade. Investors who find my trading analysis and suggestions of good quality can also use the "Follow" feature of SA to get that article.

Disclosure: I am long MS, GMCR.