Spain Weakness Returns
Michael A. Gayed | Oct 02, 2012 07:17AM ET
"The acknowledgment of our weakness is the first step in repairing our loss." - Thomas Kempis
Markets have been in a bit of a funk in the aftermath of global monetary shock and awe from SuperBen and the League of Extraordinary Bankers as the term "unlimited" was brought into the lexicon of monetary policy. The initial reaction was highly bullish, particularly following the Fed's QE3 announcement, but enthusiasm has tempered down since then. As I've been noting in my most recent series of writings, I believe that new all time Dow highs are likely in the next three months, which will likely accelerate fund flows into equities (the "Fall Catalyst of 2012"), however in the very near term the odds of a correction appear to be rising in risk assets. Intermarket trends have been deteriorating, signaling some turbulence is likely in the here and now.
One area of concern remains Spain. After significantly outperforming in the lead-up and aftermath of European Central Bank President Mario Draghi's promise to do whatever it takes to preserve the euro (FXE), sharp weakness is returning as protests mount and doubts increase over budget cuts. Take a look below at the price ratio of the iShares Spain ETF (EWP) relative to the iShares Germany ETF (EWG). As a reminder, a rising price ratio means the numerator/EWP is outperforming (up more/down less) the denominator/EWG. A falling ratio means the opposite.
Within the context of the eurozone, the trend is one way of seeing extreme sentiment on highly troubled Spain and comparatively stronger Germany. When rising, it means Spain is outperforming. Given that concerns in the eurozone are now squarely focused on Spain, it can be argued that leadership in its equities is a sign that money is comfortable taking risk. Conversely, a falling ratio signals that money is favoring "less risky" Germany.
Note the far right of the chart, where the price ratio appears to be in the early stages of rolling over. This may very well be a false move, but it is a concern to see such weakness kick in. Money still appears to be unconvinced that the worst is over for Spain, which in turn could mean Eurozone fears flare up again in October. This skepticism appears to be one reason why our ATAC strategies used for managing our mutual fund and separate accounts are sensing near-term weakness in equities. Either way, for those considering ways to play Europe, Spain appears to be not the best of plaes to speculate until more clarity occurs.
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