Positions: We currently have no European positions (including FX) in the Hedgeye Virtual Portfolio
We’ve taken our chips off the table in Europe in the last weeks, including EUR-USD, a good call given the downside in country indices (despite the recent bounce over the last few days) and uncertainty on the go-forward policy to address the region’s sovereign debt and banking contagion risks.
Below we refreshed some key charts we’ve had our eye over the last months that have helped us predict Germany’s economic slowdown and stock market crash.
The DAX is down -23% over the last two months. We think the +8.3% squeeze in the DAX over the last three days has a high probability of being short lived, and therefore there exists heightened downside risk from here. The key catalyst the market is anticipating is a passage vote from Germany on the EFSF on Thursday. The problem is that while this hurtle is significant in and of itself, the larger picture shows that any attempts to contain contagion risks will require additional hurdles, themselves much larger, which would need to include some form of a larger EFSF, bank recapitalization programs, and enhanced ECB debt buying programs. Further the question remains just how big the kitchen sink must be to contain the issue, and if it can be contained at all without default.
In the charts below we’ve highlighted our levels on the DAX, and include German sentiment charts and Services and Manufacturing PMI figures which began turning down around February of this year and have helped us to navigate Germany’s slowdown.
As we’ve stated before in our research, no country is immune to Europe’s growth slowdown, which has been augmented by sovereign debt imbalances across the periphery and the significant web of European banking exposures to one another, and in particular to the PIIGS. The domino effect—of countries leaving the Eurozone and the EUR collapsing—is one that Eurocrats remain intensely aware of; this point alone suggests their behavior will likely include attaching near-term band-aids in an attempt to “fix” far deeper, and structural problems. Here we're calling out that Europe's strongest player is down and out-- this bodes very poorly for the region's go-forward economic outlook.
We expect investors to buy the rumors and sell the news going into the critical decisions that Eurocrats will discuss in the coming weeks and months—that is to say that even given a positive outcome to the most near-term catalyst of Germany’s vote on the EFSF this Thursday there’s a long road ahead (which we think weighs to the downside) in the European project to stabilize the region.