Wednesday July 27, 2005 - 11:11:40 GMT
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Black Swan Capital - www.blackswantrading.com
Euro rally? Do you feel lucky?
"So you have to ask yourself, do you feel lucky? Well do ya, punk?"
Clint Eastwood, as Dirty Harry
It seems the economic news in Europe is getting better. Well, at the least, I think we can say it is getting “less bad.” If other players begin to see it that way, just maybe we could see a bounce in the euro.
Yesterday, Germany reported an improvement in business confidence. Not that one indicator maketh a trend. But we have noticed a couple other subtleties that suggest the “less bad” news view may be gaining momentum.
The pressure on the ECB to cut rates has receded. It seems there is now a belief that 2.0% benchmark rates are low enough because money supply growth is adequate. Many, including us, thought another cut out of the ECB was in the bag—no more. Secondly, European stocks and corporate earnings are doing quite well despite the blanket of fundamental pessimism.
This from Philip Coggan’s “Short View” column appearing in the Financial Times last Monday: “Lehman Brothers points out that of the nine US-exposed stocks in the FTSE Eurofirst 300 index that have already reported second quarter results, eight have beaten expectations. Five have beaten the consensus forecast by more than 7.5 per cent.” And “The broker argues that European earnings growth this year will be 12 per cent.”
Just maybe the rally in European stocks will benefit net capital flow to the zone, and in turn help the euro. As you can see in the chart below, the gap between the two, Euro stocks and the currency has widened dramatically. Who leads and who follows?
chart: euro vs euro stocks
We are not implying there is a direct link between the stock market and currency values. But we are saying that a rising stock market can play an important role, over time, in two ways:
1) A rising stock market tends to draw international capital flow. And that in and of itself tends to benefit a currency over time.
2) “The stocks market is one of the most important repositories of collateral,” quoting George Soros. Collateral is the raw material for borrowing and lending. So in this sense, a rising market can help spur real growth. The stock market impacts both consumer spending and business investment decisions. And a rising stock market is not a precursor to recession—the recession we had believed the euro zone was about to enter.
We know surprise moves prices. And we think an improvement, or less bad news, on the European economic front would represent surprise. So maybe we shouldn’t assume the euro is down for the count just yet. A break of the 11900-level would probably do the trick, however. For now, stay tuned.
Black Swan Capital
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