The United States is frequently credited with being the largest economy in the world. Indeed, the U.S. produces the greatest market value of final goods and services per year.
On the other hand, when an economy is not defined by national borders, the European Union can be credited with the largest Gross Domestic Product (GDP). And it is this fact that financial markets may have been underestimating since July 26, 2012.
Roughly one month ago, the president of the European Central Bank (ECB) famously stated that policy-makers will “do whatever it takes to preserve the euro.” In fact, since Mario Draghi strongly hinted that the ECB would be able to buy bonds in the way that the Bernanke’s Federal Reserve has done with its quantitative easing, both the CurrencyShares Euro Trust (FXE) as well as Vanguard Europe (VGK) have soared.
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Ironically, there’s no growth in the eurozone to pull the region out of its recession. Earnings in European companies - even the finest multi-nationals - are likely to get smaller and smaller.
That said, Draghi is not the first European leader to instill temporary confidence. One-time ECB Governor Trichet dodged a credit collapse in early October of 2011 by serving up loans to a dozen major European banks and pledging to spend $40 billion euros in covered bond purchases; CurrencyShares Euro Trust (FXE) ceased its free-fall and began climbing. Similarly, the managing director of the International Monetary Fund (IMF), Christine Lagarde, chatted up the markets and the euro-dollar in mid-January. The monster request for $1 trillion over the next several years to manage global financing needs bolstered CurrencyShares Euro Trust (FXE) once more.
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In each prior instance (October 2011, January 2012), CurrencyShares Euro Trust (FXE) eventually broke to new lows. And while one might like to believe that Draghi’s July 26 promise will be an example of ”third time’s a charm,” FXE will likely falter yet again.
Granted, markets have been willing to take Draghi’s comments at face value for the last month. Yet governments in the eurozone do not necessarily agree with the prescriptions that the ECB or IMF are putting forward. In particular, Germany’s Bundesbank Head Jens Weidmann as well as German Chancellor Angela Merkel may eventually do or say something that contradicts the ECB’s verbal assurances.
In truth, CurrencyShares Euro Trust (FXE) has been faltering at the resistance of its 100-day intermediate-term trendline. If FXE stumbles at its 100-day yet again, it might be reasonable to assume that investors fear systemic risk for the financial system as well as ongoing economic hardship for the globe’s largest economy; developed world and emerging markets stocks would retreat.
PowerShares Dollar Bullish (UUP) also depicts the likelihood of potential risk aversion. Not since the “sell-in-May” swoon have we witnessed a mad dash to own the greenback. If the current price of UUP hangs around its intermediate-term moving average instead of moving lower, investors may lose faith in the resolve of a “united” eurozone.
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Keep in mind, an investor who wishes to hedge against ownership of world equities might want to purchase UUP. Over the last 6 months, PowerShares Dollar Bullish (UUP) has moved in the opposite direction of the iShares All-Country World Index Fund (ACWI) 80% of the time.
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Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.