Avoid European Stocks Until the Euro Stops Falling

On January 22nd, the European Central Bank announced the start of its Quantitative Easing (QE) program that will involve a larger than expected 60 billion Euro asset purchase per month. The Fidelity Europe Fund (FIEUX) responded with a rally, but it has not yet cleared the resistance level (see blue line on the chart):

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At the same time, the Euro continued to drop against the dollar, which explains why European stocks are less attractive in U.S. Dollar terms:

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The picture is completely different if we look at European equities in Euro terms. This chart shows a very bullish break out:

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Stock Market Correction Causes Flight to Safe Investments

As the equity market correction unfolds, the current list of the top 10 Fidelity mutual funds shows a dramatic shift compared to what we have seen throughout the year: seven out of the top ten funds are now income funds.

 

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One of the most important new developments is that the yield of the 30-year Treasury bond continues in a downtrend causing long-term Treasury bonds to to resume a very strong uptrend:

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The weakest investments that I highlighted in previous blog articles, such as mutual funds investing in the Eurozone and energy, have continued to decline. However, they are so oversold now that it would not be surprising to see a relief rally.

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The market leaders of the last 12 months, including technology and communications sectors, are turning over now, which is a worrisome sign about the short-term prospects of the stock market:

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Small Cap Stocks are Hit the Hardest as the Market Correction Unfolds; Avoid the Falling Knives; Large Cap Stocks and Biotechs Can Lead the Market when the Next Rally Arrives

Today was a tough day for stock investors. A toxic brew of bad news caused another round of market sell off, but now the volume is increasing, which is definitely not a good sign. The Russell 2000 index, representing small cap stocks, was hit the hardest out of the major U.S. stock indexes. Small cap stocks typically outperform during the expansionary phase of the economic cycle. Consequently, the underperformance of the small cap index versus the large cap S&P 500 index is a worrisome sign.

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In spite of the best efforts by the ECB, increased concern about economic contraction in Europe has caused Eurozone markets to enter a downtrend in July. As the Wall Street adage says, “do not try to catch a falling knife”, we believe that investors are best served to continue to avoid Eurozone investments until the proverbial knife hits the floor. Currently, no floor is in sight.

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Crude oil and other commodities tend to be priced in dollar terms, so as the dollar rallied against all major currencies starting in July, stocks in the energy sector to sell off. The sell off is also exacerbated by concerns about a possible world-wide economic weakness. We will continue to watch the relative strength of the energy sector compared to the S&P 500 index to look for a turn-around that may be similar to what we have seen in February.

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On the bright side, the bull market is still intact for large cap stocks as investors seek out the safety of blue chip companies. As we reported earlier (see article), a rotation of capital is under way into large cap stocks.

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Biotechnology is another area of the stock market that is still holding up. While investing in the biotech sector is appropriate only for aggressive investors, tracking this sector can give us clues about the ability of the stock market to rebound from the correction.

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European Markets in Downtrend

Both weakening economic conditions outside of the U.S. and geopolitical risks have caused the dollar to strengthen against all major currencies since May, including the Euro:

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The weak Euro coupled with renewed fears about recession in the Eurozone have negatively impacted European equities. Prudent investors may want to avoid investing in European equity markets until the downtrend reverses.

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