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Trading on Emotion ? Eurozone Blues

Stock Market Trend: Decisively Broken 

Last week, I indicated that the market trend was broken and that the best strategy for a risk-averse retail investor in the absence of a clear upward trend was a move to cash.  So emotionally, just how did you handle that observation when the stock market soared on the following Monday?

If your reaction to that sucker’s rally was, “Boy, I wish I’d been in the market and that Navarro is an idiot,” then you may not quite understand the underlying macro logic of a cash call in the absence of a definable trend.  At times like these, market participants have no clear consensus view on the future direction of the economy.  Some look at the robust leading economic indicators here in the U.S. and a (slightly) improving job market and are bullish. Others look at the Eurozone debacle and see a collapse of the global economic recovery and are bearish.

At such times, “playing the market” is like playing roulette.  It’s a 50-50 gamble (less your trading costs) rather than an intelligent speculation.   In such circumstances, you may well experience the “high” of winning for a day such as we had last Monday.  BUT you are just as likely to get hammered – as the market was in the last two trading days of the week.

The broader point here is to get your emotions out of your trading.  If the market has an up day in times such as this when there is no clear market trend, don’t regret sitting on the sidelines.   When the market has several down days, don’t even gloat that you were out of the market.  Just wait and watch for the trend to reestablish itself and then implement whatever stock-picking strategy you have found to be best.

The Euro is Dead

Now let’s switch gears and talk about where the trend is likely to go – up or down – and what the falling euro means:

1. The euro is likely to continue in a long term decline.
2. The euro will continue to decline because “Le Tarpe” will either lead to a massive boost in the euro money supply OR a collapse of the euro if countries that want to borrow “Le Tarpe” funds refuse to agree to the conditions of accepting the money.  There is NO third option so the euro must fall!
3. A falling euro will hurt the U.S. economy directly by reducing U.S. exports to Europe.  But this is a small effect since European exports only account for about 2% of the U.S. GDP.
4. A falling euro will indirectly hurt the U.S. economy by reducing the probability that China will revalue its yuan relative to the dollar.  This is the far greater impact because it will mean continued trade deficits with China here in the U.S.
5. China won’t revalue the yuan at this time because as the dollar is rising, so, too, is the yuan.  This hurts Chinese exports to Europe – its largest market.  Ergo, there is no way China would allow further strengthening of the yuan to the euro by strengthening the yuan relative to the dollar!!!  (If you don’t understand this one, please re-read until you do.  It is the single most important dynamic right now in the global recovery besides the euro collapse itself.)
6. The decline in the euro boosts gold and silver prices by raising the probability that gold and silver will be de facto “reserve currencies” in a world where high sovereign debt levels in both the U.S. and Europe make the dollar and euro less attractive as reserve currencies over time.
7. The usual positive correlation between gold vs. oil and commodity prices has been decisively broken by the euro crisis.  A stronger dollar drives down oil and commodity prices BUT a weaker euro boosts gold as a reserve currency play.
8. It is easier to paint a bearish global scenario from the euro collapse than a bullish one.  The bearish scenario is this: Europe stagnates as “Le Tarpe” fails because of political pressures that were not present in the U.S., i.e., while the U.S. could make demands on Citi and AIG et al, the Eurozone bigwigs can’t bend Greece and Portugal and Spain to their will.  China implodes on a combination of collapsing real estate and stock market bubbles coupled with a fall in exports to Europe.  The U.S. continues to be leached by Chinese mercantilism and it loses its export growth in Europe while internally states like California and Illinois undertake contractionary measures that ripple across the nation.

Of course, despite this colossal bummer scenario I have presented, the global economy may still recover and the bullish market trend may soon resume.  But to come full circle, why would you want to be fully invested on the long side at this particular point in time?  Unless, of course, you prefer emotional gambling to intelligent speculation.

I leave you with this observation from Market Edge about the technical condition of the market:

The technical condition of the market stayed in a weakened state last week as the CTI and the Momentum Index remained in bearish territory while the Strength Indexes collapsed.  Following the nasty sell-off which occurred the week ending 05/07/10, it came as no surprise to see the market bounce last week. What was somewhat of a shocker was the size of the rebound which saw the DJIA gain 3.9% and the NASDAQ 4.8% on Monday alone. Despite the fact that both the DJIA and the NASDAQ finished the week with a gain, the technical picture continues to point to rough sledding over the next several weeks. … With the negatives far outweighing the positives, the probabilities are high that the correction has a way to go. Typically, sharp declines are followed by a series of failed rally attempts over a 3-4 week period with a valid test of the previous lows needed before a genuine rally can develop. Monday's bounce was a good example of such a bounce.