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The Fall Of The Euro

08/05/11 01:38:43 PM
by Billy Williams

The 10th largest price drop in market history was made and the specter of another recession looms on the horizon but while markets decline, money flows to new opportunities if you know where to spot them.

Security:   TNX, UST
Position:   Hold

History was made as it was reported that the Dow Jones Industrial Average's 512-point price drop was the 10th-largest decline in the stock market's history. In the US, stocks are in full retreat as they undergo a massive price correction and the question has shifted from "Where does the market go from here?" to "How far will it drop?"

The stock market has been the one bright beacon shining over an ugly landscape of poor economic data, and on Friday, August 5, 2011, it released its job numbers on the heel of nine days of surging distribution as a result of negative pessimism flooding over traders and investors who are looking to find greener pastures. The feeling on Wall Street is that there are no jobs being created, so no consumers to purchase goods and services from the companies that make up the very stocks they are holding -- worse, no shoppers flush with cash as Christmas awaits just over the horizon and, with major retailers looking to make their year during the holidays, this lack of discretionary income during the holiday season creates a gloomy forecast that many feel is not worth the risk of holding equities. See Figure 1.

Already, the specter of another recession could appear in early 2012, if not sooner.

Compounding the problem is Europe.

FIGURE 1: UST. UST, an exchange traded fund (ETF) that tracks the 10-year Treasury note, reveals a steady upward rise in the price of bonds as investors flee equities for the safer shores of US debt as a result of massive stock market selloffs. With the flow of capital shifting from equities to bonds, you can look to short stocks and buy bonds in order to hedge your portfolio.
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European banks don't lend to small businesses because entrepreneurism is practically an endangered species on that continent, so sovereign lending is the cornerstone to the European banking market. Sadly, a quick glance at the state of the European Union reflects how poor a business strategy that is, with most French banks practically insolvent once you take away the creative accounting allowed by their current laws, which, incidentally, does little to solve the problem, other than to kick the can down the road.

Most EU countries like Spain, Portugal, Italy, Ireland, and Greece have created a literal daisy-chain of overlapping loans, which is what they are currently feeling the weight of. As the ever-increasing debt rises, they are faced with a decision in order to stay afloat, which no one wants, but for them, their only salvation may be to exit the EU in order to devalue their currency. See Figure 2.

FIGURE 2: TNX. As bonds rise, yields fall. TNX, an ETF that tracks the 10-year T-note's yields, reveals a steep decline as bond sellers offer lower yields to hungry bond investors who are willing to take a lower yield that still promises the safety and security of US debt.
Graphic provided by:
Already, Italy had slipped that it was considering exiting the EU, which would put the euro on a steep decline. In fact, any minor EU partner could exit the EU before the end of the year, creating a window of opportunity for a major EU partner to exit as well in order to get out from under the bureaucratic tyranny of the EU so that they can have a reasonable chance to deal with their own individual crisis at home.

While the euro won't just go extinct, it will decline sharply before the Germans, who control the currency, shore up its strength, causing it to trend upward again.

The one silver lining for the US is that global traders are fleeing European equities in a flight to safety by pouring investment capital into the 10-year Treasury notes. This flow of investment capital into the T-note will result in the note's yields falling, since demand is rising as investors seek safe returns without the current market's volatility.

In addition, you can expect strong currencies like the Swiss franc and precious metals such as gold and silver to rise as nervous investors sit on the sidelines till stability begins to enter the market and calms its choppy waters. Once it does, however, equities will be a strong value in respect to their earnings versus share value, creating acres of "diamonds" for the shrewd investor.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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