March 10, 2014
Consider the following European issues:
1) The northern Bear is not hiding from view of the European Union and their collage of friends (NATO, United States, IMF, etc.). The threat of war sitting on their doorstep or severe social unrest is in the hands of Putin, who at the end of the day, is the one calling the shots.
2) Europe suffers under a bipolar financial union between the northern industrial members and the southern socialists. The north is carrying the south much to their collective consternation. The threat of disunity lingers and is perturbed with each schnitzel redistributed to their brethren whom now only expect these handouts to continue as if it’s the German’s plight for sins of the past.
3) Europe currently receives 40% of their energy from the Bear without a real backup plan if Russia decides to sell its oil and gas to China and/or Japan. This doesn’t leave the EU with a great deal of leverage at the negotiating table.
4) The Euro, the currency of the European Community member states, is on the rise despite actions of the European Central Bank (ECB) to continue near Zirp interest rates and with considerations of negative rates forthcoming. The rising Euro/USD will primarily harm the region’s largest exporter and most dominant economy … Germany. Short term, this condition (lower USD vs. Euro) will benefit U.S. companies with the majority of their revenues outside of the States; which now represents greater than 50% of the S&P 500.
Now consider these:
1) A declining dollar (USD) is a determinable net negative for foreign capital flows into the U.S. as dollar related assets (U.S. stocks, bonds and real estate) will be depreciated directly proportional to the dollar depreciation versus the foreign investor’s home currency. This reality is particularly important when the investor is either considering, or participating, in fixed return assets (bonds, real estate, commercial buildings with long term rents, etc.). If the condition persists, or at worst is expected to persist, the likely outcome is disintermediation of dollar assets either by ceasing further capital flows into dollar assets or to flat sell them outright into largely illiquid market’s.
2) The Fed’s dilemma is whether to defend or abandon the dollar. If the Fed’s policies remain undeterred, i.e., continuing QE (Quantitative Easing) with the transparency of long term Zirp interest rate policy and perhaps a lessening of tapering (or a reversal thereof), then the USD will likely suffer further declines internationally. Already the dollar index is now at 52 week lows; a break of the dollar index of 79 could push this index to the low 70’s.
3) If the Fed defends the dollar by increasing tapering, ending QE or raising interest rates substantially (all of which would be needed to stem a dollar exodus), then stock markets hinging on the monetary stimulus drug will come unhinged. The result will likely be severe and persistent downside selling pressure for months on end.
4) The Obama administrations’ (most notably, Obama himself) “lines in the sand” are becoming transparent to the global community as drawn with invisible ink. As Syria clearly “crossed” the Obama line with their pronounced use of chemical weapons, Obama was “bailed out” by the aspiring world leader Mr. Vladimir Putin. Now that Obama has drawn another make believe line in the sand on Russia, will Putin again come to his rescue with a solution of compromise … and if so, what will that be; Russia annexation of Crimea, the fragmentation of the Ukraine or perhaps of Europe itself?
5) The furtherance of chatter regarding the replacement of the USD as the reserve currency is likely to be promoted; most likely by those holders of the predominant fiat USD credit instruments AND the energy importers of the world.
6) Lastly, and not to be dismissed, we reiterate that the U.S. economic agencies (the Fed, the Treasury and the White House Economic Advisory team), have no market experience … none. A first in at least the last 50 years and perhaps since the beginning of the Federal Reserve in 1914. This alone could lead to a very fat-tail distribution that is absolutely not anticipated or discounted by market prices.
To condense the above parenthetically, the unknown force to derail the stimuli induced bull market in equities may well be a drop, or exodus, of that in which those equities are denominated. Beware of a dollar index drop below 79 and a potential precipitous fall to 73 thereafter.
The Professional Traders Opinion
Ronald M. George
William J. Taylor