We have seen the blatant attempts of world powers trying to keep the markets propped up while the headlines and economic numbers are flush with discouraging news. But, somehow we have found our domestic markets, such as the S&P 500 (SPY) and Dow Jones Industrial Average (DIA) slightly off their yearly highs. Though domestic growth is moving at a snail's pace, it is indeed moving. We all know the road to recovery will be a rocky one, but at home we're doing okay.
Who's not doing okay? The Europeans. The continued struggle in Europe is and has been bleeding into our own American companies. Many corporations that have international exposure are beginning to see Europe weigh on their balance sheets and drag down their earnings when it comes time to report. This is blatantly obvious when looking at companies like Ford (F). Though sales are doing fine--great actually--in America, Europe has been causing the stock to sag after recently taking on a new 52-week low.
Charts courtesy of stockcharts.com
Six-month chart of Ford (click to enlarge).
Last week, Mario Draghi ignited a buying spree when he stated they'll do, "whatever it takes to preserve the euro." While the ECB lightly delivered on that, it still has not found a way to truly fix the European problems. The continent still needs Germany to fully commit toward a bailout package and it is going to take a lot of money for all of this to play out successfully. However, make no mistake that despite the market rallies we have been seeing, trouble still looms very close.
Italian 10-year bonds are currently yielding 6.00% while Spanish 10-year notes are currently yielding 6.75%. It seems as though the Spanish 10-year cannot fall too far past 7%. For those who are aren't "bond-atics" a yield above 7% would suggest being unsustainable, therefore stating that the borrower--Spain or Italy in this case--might not or will not be able to pay back the lender. So when we see these two countries' 10-year notes shoot up past 7% the markets seem to get a little panicky and start dumping assets, mainly stocks.
| Country | Unemployment Rate |
Portugal | 15.2% |
| Italy | 10.2% |
| Ireland | 14.9% |
| Greece | 22.6% |
| Spain | 24.6% |
| EU* | 11.2% |
*EU unemployment rate is taken from the 17 countries that use the euro as their currency.
While looking at the chart above you will notice not one of the PIIGS countries has an unemployment level in the single digits. Furthermore, Spain has nearly a quarter of its workforce doing nothing. The European Union as a whole has over 11% unemployment. Though a stimulus package or bond-buying program may help lower lending costs to these countries and slow down their impending collapse, there is something that is more important: growth! Without growth there is no way any of these countries are going to be able to crawl out of the hole they are falling down. Without growth they will not be able to sustain rising lending costs and pay them back, even with the ECB trying to help.
What does all this mean? It is clear to nearly everyone, that Europe is indeed, not okay. Certainly there will be struggles and a lot to overcome. In my part I am not calling for an apocalyptic event (though the U.S. fiscal cliff will certainly add to the drama) or anything of that matter. Also, I am not suggesting a solution to fix the euro. I am simply searching for trades and digesting the information I receive.
The more the ECB does to step up and help the struggling countries, the more it will cost. Essentially two assets will be affected directly (with the exception of other currencies). The euro should plunge and gold should continue its rise. The dollar would also be affected with a declining euro, but also has its own printing press.
One-year chart of FXE, the euro currency ETF (click to enlarge)
After reviewing the chart above as well as applying the fundamental basis of the euro, there is no reason to think it will stop its long decline. The euro, currently trading near the 124 level, is resting just below the 50-day simple moving average, and quite far from the 200-day simple moving average. While I do think the next several days or possibly weeks will allow the euro to climb higher (in part, from Mario Draghi), I do expect the euro to continue its longer-term decline.
There are several ways in which to play the ensuing euro fallout. The most direct way would be head into the currency markets and short the euro. This is also a plausible trade in the futures market as well. Another way we could participate in this event would be by longing the USD. As the euro declines, the dollar rises. Another way to trade a declining euro would be to outright short the FXE, the Euro ETF (in the graph above), or by using various options strategies around that asset.
Still, I think the euro will continue to edge higher in the short term, especially if it can close above its 50-day simple moving average. Though, in my opinion, fundamentals are more important in this case, technicals do play a role and are important. I expect the euro to creep closer to 1.25 or 1.26 and these are the levels, should it get there, that I will be looking to enter a short position.
In all there are many different ways to play a declining euro, and it may rise through my initial target of ~1.26, but I don't think the fundamentals are strong enough to let it go much higher. In any case, an unknown news announcement could spike the euro in either direction, but over the long term, I don't expect it go much higher, before going much, much lower. Remember, even though markets seemingly continue to rally, many investors and traders have one foot out the door. Don't bite on the head fake.
Disclosure:I may initiate a short position in either the FXE or the Euro via futures market in the next 72 hours.
