The condition of Europe has become
the psychological linchpin governing the world’s financial
markets. Even the notoriously
insular American investors are fretting about Europe’s
woes on an hour-by-hour basis, which is incredible. The euro currency has become the focus
of the global Europe fears, trying
unsuccessfully to shoulder this crushing burden. The result is the euro’s recent
panic-like plunge.
I sure don’t use the word “panic” lightly. In stock-market terms, a panic is a
20%+ plunge in the headline stock indexes in 3 or 4 weeks. In October 2008, the flagship S&P
500 (SPX) plummeted 30% in 21 trading days! Panics always cascade into existence
in weak markets from already-low prices.
Before that October 2008
panic month hit, the SPX had already fallen over 22% in its cyclical bear market.
This is in contrast to crashes, which erupt in very strong markets
usually near the ends of secular bulls.
In stock-market terms, a crash is a 20%+ decline in the headline
indexes in 2 or 3 days. Since the euro’s recent plunge
emerged out of weakness and lows, it definitely isn’t a crash. The definition of a panic is “a
sudden widespread fear concerning financial affairs leading to credit
contraction and widespread sale of securities at depressed prices in an
effort to acquire cash”.
This definitely fits the euro situation.
Currencies move much slower than the stock markets in general, so the
20% stock metric is certainly too steep to define a currency crash or
panic. Over a brutal 4-week span
ending this week, the euro plunged 9.5%!
For the gigantic currencies which usually move with glacier-like
lethargy, such a fall over such a short span is certainly
“panic-like” if not a true panic.
While technicals measure and quantify panics, it is psychology that spawns and sustains
them. And in sentiment terms, the
euro is definitely deep in the throes of an epic panic. The bearishness, pessimism, and fear
surrounding the euro is mind-boggling.
Nearly everyone expects it to continue lower in an endless death
spiral. A growing fraction of traders
is even predicting parity soon, the
euro trading at $1.00 even. That
is another 18% lower from this
week’s lows!
Fear has to be extreme to
drive a panic, and we are certainly seeing the euro plagued by extreme fear
today. But extreme emotions are
never sustainable. Excessive fear
quickly burns itself out. Soon
everyone who wants to sell has already sold, and when selling pressure
climaxes the panic is over. And
somehow the world marches on as the news that whipped up the emotional frenzy
quickly fades from memory. The
more extreme the emotions the less sustainable they are, and hence the
shorter the event.
This is why panics, and the ridiculously-low prices they generate,
represent the best buying opportunities ever witnessed in the financial
markets. In early March 2009, I was railing against the same type of fear extreme in the US
stock markets. I wrote,
“Despair reigns supreme and seemingly only fools hold out hope that
things will materially improve anytime soon. … When things look the
bleakest is exactly when we need to hold our noses and buy. …all the
ingredients are in place for a monster rally.”
And indeed between that very week and late April 2010, the SPX
rocketed 79.9% higher in one of the biggest stock-market rallies of modern
times. The brave contrarians like
our subscribers not afraid to buy into extreme fear made fortunes, but the
vast majority of investors lacked the courage and missed most of the
upleg. Due to the euro’s
deeply-oversold technicals and extreme fear, I believe a similar epic buying
opportunity exists in it today.
Most would laugh derisively at this heretical assertion. They would bludgeon it with many
fundamental arguments on why the euro has
to continue plunging. Yet the
majority said the same thing at the March 2009 stock-market lows. They argued fundamentally that a new
depression was upon us, and that the new big-government-socialist regime in Washington
would suck the life out of any recovery.
But despite these popular and seemingly-logical arguments, the stock
markets still soared 80% in just over a year.
Lows driven by extreme fear are never sustainable because extreme fear
itself is never sustainable.
Investors faced with a new situation today that terrifies them will
quickly adapt to that new reality.
And within weeks this very same situation will no longer terrify
them. Their extreme fear will
evaporate as the threat becomes old news and routine. If you are scared of snakes now, a few
weeks working in a reptile garden will largely eliminate that visceral fear
response.
Europe has problems, no doubt.
But big government and out-of-control spending has been a problem all
over the world for centuries. And
it has grown far worse in the decades since gold’s iron discipline was
kicked out of the world currency system.
Yet somehow, over the past decades and centuries life has soldiered on
despite endless government excesses.
No matter what happens in
Greece, it doesn’t matter!
At less than 3% of Europe’s GDP, Greece is trivial. So are the other troubled countries.
The incredibly bullish outlook on the euro today is not based on
fundamentals, but technicals and sentiment. There is no better time to buy
anything than when everyone thinks it is heading to zero in the heart of a
panic. Nathan Rothschild’s
famous quote of “buy when there’s blood in the streets” is
one of the core tenets of contrarianism.
With today’s wild popularity of the euro-to-zero trade, and the
universal extreme fear, this time-proven wisdom has never been more
appropriate for the euro.
The charts really drive home this point. These two charts of the euro and US
Dollar Index need to be digested as a pair. The USDX is the premier metric for
measuring the US dollar’s progress, and the euro dominates it at 57.6%
of its weighting. Also rendered
are each currency’s Relativity trading bands, or where they are trading as
absolute multiples of their baseline 200-day moving averages. These define extremes and show how
wildly out of whack the euro has become.
Prior to late 2008’s once-in-a-century stock panic, the euro was in a strong secular bull while the dollar was in a
strong secular bear. These major
trends had started way back in the summer of 2001 and had a rock-solid
fundamental basis. While both the
euro and dollar are inherently-flawed fiat-paper currencies backed by nothing
but faith in their issuing governments, the euro was much less mismanaged
than the dollar was.
Europe was not expanding its broad money supply as fast as Washington,
so its inflation risks were lower.
Europe’s central bankers, having witnessed firsthand the
devastating impacts of runaway inflation in the last century, have always
been far more conservative than the Americans running the Fed. Europe was paying higher interest
rates, making the euro more attractive to global investors. And the world’s central banks
were way over-allocated in US dollars and under-allocated in euros, so they
diversified out of dollars into euros.
Naturally the euro marched higher while the dollar drifted lower.
You can see each currency’s relative trading range in the years
before the stock panic. They
generally were pretty tight. The
euro tended to meander between its 200dma during healthy corrections to 10%
above its 200dma near the peaks of big uplegs. At the same time the dollar drifted
between its 200dma during bear-market rallies and 8% below its 200dma in big
downlegs. These are
perfectly-normal secular-bull and secular-bear behaviors respectively.
By April 2008, the euro had hit an all-time high while the US dollar
hit an all-time low. And for the
following few normal pre-panic
months, the euro consolidated near its highs while the dollar consolidated
near its lows. It was these
levels, driven by 7 years of
carefully-thought-out capital migrations, that were the best pre-panic
fundamental read on where these competing currencies ought to be
trading. Contrast those
spring-2008 levels to today’s hysteria-driven extremes.
2008’s panic was actually two-phased, a bond panic closely
followed by a stock panic that drove general fear to previously-unimaginable
levels. As investors lost faith
in bond and stock markets worldwide, they flooded into US dollars and US Treasuries as safe havens. This drove the biggest and fastest US
dollar rally ever witnessed, an epic 22.6% USDX spike in just 4 months!
Since the euro is the dollar’s primary competitor, it naturally
plunged over this epic-dollar-rally span. The euro hit deeply-oversold levels
around $1.25 after falling 21.7%.
Was this panic euro plunge driven by poor euro fundamentals? Of course not. It was simply the fallout from a mass
exodus into safe-haven dollars after the first true stock panic of modern
times. Provocatively in November
2008, the euro bottomed and the USDX topped on the very same day the SPX bottomed. The stock woes drove dollar buying,
and the euro was simply collateral damage.
Provocatively, near the euro lows in late 2008 mainstream consensus
argued the same thing about the euro and dollar that we hear today. They claimed the euro wasn’t
viable after a decade of life and a powerful secular bull. They claimed Europe couldn’t
handle the financial stresses of the panic since it was a fragile patchwork
of countries with disparate interests and needs. But the reality was the euro was
deeply oversold and the dollar radically overbought. Emotional extremes that couldn’t
persist drove these anomalies.
As the stock markets soared up out of their irrational panic lows in
December 2008, the euro rocketed 15.4% higher in less than 4 weeks while the
inflated dollar collapsed 10.6%.
This trend held until the stock markets started rolling over again,
when worries about the imminent socialist takeover of Washington inflamed
fears that a new depression was inevitable in the States. So once again between mid-December and
the March 2009 stock-market lows, flight capital rushed into the dollar so
the euro took a serious hit.
Then again in early March 2009, the USDX made new highs and peaked on
the very days the SPX made new lows and hit its ultimate bottom. Its 13.3% rally drove a parallel 12.7%
euro plunge. Once again the euro
bounced near $1.25. As you know
if you were the least-bit interested in the markets in March 2009, the fear
and despair then were overwhelming and utterly unsustainable. As those emotions faded, the oversold
euro soared while the overbought dollar plunged.
By late November 2009, when the stock markets were no longer scary,
the euro had rallied 20.5% to around $1.50 and the dollar had lost
16.7%. But by that time the euro
was overbought and the dollar was oversold, as I warned our subscribers about
heading into November. Near the
edges of their relative trading ranges, the euro was due for a correction
while the dollar was due for a bear-market rally. And
indeed as expected those healthy interim reversals to rebalance sentiment
soon came to pass.
Remember that both bull-market corrections and bear-market rallies
tend to reverse near their 200dmas.
So for both the euro and the dollar, these healthy short-term
reversals looked normal into February 2010 when they hit their respective
200dmas. Absent all the Europe
hysteria, the euro and USDX probably would have reversed decisively sometime
in February (where it averaged $1.37).
The euro would have continued back up while the dollar ground lower on
the same fundamentals that had driven these currencies for many years prior to the panic anomalies.
But the festering Europe fears gradually drove the euro lower while
the dollar caught a bid, extending their reversals far beyond where probabilities
suggested they ought to stop. The
result is the nearly-vertical and unsustainable euro plunge and dollar spike
we’ve witnessed in the last month or so. As you can see in these charts, this
hyper-emotional event drove both the euro and dollar to crazy extremes.
As of this week, the euro was back down to early-2006 levels. Is this rational? Given the euro’s superior
fundamentals (slower monetary growth, more conservative monetary policy,
higher interest rates, under-allocation by central banks), does it make any
sense for this currency to erase several years’ worth of bull-market
gains in several months? Is it
rational to see the euro now trading below its lows from the stock panic,
when global investors really feared a new worldwide depression? No way.
On the other side of this coin, today’s dollar levels look just
as irrational. The USDX is back
up near its panic highs! We are talking about places it went
when the VXO fear gauge was running in the high 80s in October and November
2008 and the mid-50s in early March 2009. Lately it has only been in the low
30s, so general fear isn’t even close to as high as the last time the
USDX saw these levels.
And given Washington’s out-of-control spending, the asinine
zero-rate policies of the Fed, the Fed’s incredibly inflationary monetary growth, central banks’ massive over-allocation in US
dollars, and the terrible yields on US Treasuries, does it make sense for the
US dollar to be trading at levels last sustained
in early 2006? Nope. Today’s dollar highs are merely
an emotionally-driven anomaly just like they were during the stock panic. The extreme fear hammering the euro
and driving the dollar buying will be no more sustainable than the
stock-panic fear was.
Investing and speculating are about buying low and selling high. The reason contrarians are the most
successful at this game is because we ignore our own emotions and buy into extreme fear and sell into
extreme greed. Extreme fear and
greed manifest themselves on the charts as exceedingly large moves in short
periods of time. The faster and
more anomalous any move, the more intense the emotions that drove it and
hence the less sustainable it is.
As I wrote last week in an essay on euro gold challenging €1000 for the first time ever, I am no fan of the
euro. Like the US dollar, it is a
fiat currency backed by nothing but faith in its issuing governments. It will slowly devalue towards zero
just like all paper currencies.
But fundamentally it is the
lesser of these two fiat-paper evils.
It has been in a strong secular bull while the dollar has languished
in a long secular bear. These
fundamentals didn’t suddenly evaporate due to little Greece’s
sovereign-debt problems.
The euro is radically oversold today while the dollar is radically
overbought. Fear permeates every
aspect of the euro while greed clouds traders’ fundamental judgment on
the dollar. Neither of these
emotions, nor the extreme price anomalies they have recently driven, are
sustainable. Going long the euro
today is as good of bet as going long the SPX was near its March 2009
lows. When everyone expects
anything to go to zero, when the entire financial media harps on this
incessantly, it is an epic buying opportunity.
Interestingly, I suspect this euro-plunge causality might not be
working in the direction everyone assumes. Today everyone thinks Greece fears are
driving Europe worries which are hammering the euro, commodities, and stock
markets while the dollar rallies as a consequence. But perhaps, just like during the
euro’s late-2008 plunge, the US
stock markets are the stealthy dominant driver.
The SPX topped at 1217 in late April. It had relentlessly rallied 15.2%
since early February, a huge and very unbalanced move with almost no
meaningful down days. This SPX levitation act made traders very nervous, and everyone was looking
for a healthy pullback to rebalance sentiment. They wanted an excuse to sell stocks, and the latest round of Greece
fears conveniently created one.
Remember that the European sovereign-debt worries are nothing
new. We’ve been hearing
about Greece, Portugal, Spain, and sometimes Italy for at least 6 months now.
And indeed, the euro had weathered the ceaseless drumbeat of Europe
pessimism rather well between late November when it was overbought and
mid-April. When the SPX first
broke above 1200 that month, the euro was running $1.37. That was on the low side, appropriate
for a correction, but nowhere near extreme.
Then as soon as the SPX selling started, the euro got sucked in. Just like during the stock panic, a big flight-to-safety sell-everything-buy-dollars
trade emerged. The USDX tended to
get bid higher on days the SPX fell, thus the euro also fell on days the SPX
fell. So perhaps this whole euro
panic is more the result of dollar flight capital spawned by the biggest
pullback of this SPX cyclical bull.
The financial media always tries to
justify existing price movements, but the factors attributed and
causality are often muddled.
At Zeal we are lifelong students of the markets and pride ourselves on
being hardcore contrarians. We
buy low and advise our subscribers to follow when prices are oversold and few
others want to buy. This gives us
excellent entry points for very profitable trades. Today’s radically-oversold euro
is one of the most extreme low-price anomalies I’ve ever seen. I can’t imagine it not reversing
soon and violently, with the resulting euro relief rally being blisteringly fast
just like it was in early 2009.
This has huge implications for commodities stocks, as the rallying
dollar and falling stock markets have really depressed them lately. We are heavily deployed in
precious-metals stocks, which should thrive as the dollar retreats and gold
surges. We are also taking
advantage of the weak commodities prices to deploy into other
commodities-stock sectors. Subscribe today to our acclaimed weekly or monthly newsletters and take advantage of the awesome buying opportunities these wild markets are offering!
The bottom line is the recent precipitous plunge in the euro was
either a panic or panic-like event.
It was driven by extreme fear that simply isn’t
sustainable. The fate of Greece,
or the other small peripheral debtors, is irrelevant. The euro fell too far too fast and hit
totally irrational levels that have nothing to do with fundamentals, and
everything to do with runaway emotions.
Odds are this will soon reverse with a big and fast euro rally.
This has widespread implications for the US dollar, the US stock
markets, and commodities stocks.
A fast-rallying euro will directly hammer the dollar and calm Europe fears,
leading to new stock-market and commodities buying. The commodities stocks, many very
oversold thanks to this SPX pullback, have the potential for exceptional
gains. But as usual, only the
emotionally-neutral contrarians will capitalize.
Adam Hamilton, CPA
Zealllc.com
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information.
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read all messages though and really appreciate your feedback!
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