The dominant influences on Equity markets that we can see are two – firstly the continued compression in the Dow transport index, which made yet another weekly-scale signal last week:
This latest compression was produced at the 'tightest' setting that we can use - this is a very strong signal and argues that a new move is imminent. Which way? As ever with compressions, we can't tell, only that something big is brewing and that the eventual move will last for several months. From time to time we will continue to provide shorter-term views of the US market that could help to take a position that will be in the direction of the eventual break. For now, we wait.
The second influence is in Europe and has become something of a favourite – it is the consequence of tethering disparate economies together in the Eurozone to cope with the same exchange and interest rates, despite their differing circumstances. This pushes Germany and some of its neighbours toward ever greater economic success while condemning the Southern fringe to ever greater failure and poverty. This has become more widely recognised since we first pointed it out over a decade ago but still there are points that are generally overlooked:
Germany’s economy represents almost 30% of the Eurozone (and growing) and the contribution from its ‘virtuous’ neighbours Holland, Belgium, Finland and Austria is another 11%. Even allowing for the ‘doubtful’ membership of Austria in this select group, this means that over 40% of the ouput of the Eurozone benefits from the single currency. German labour costs and general economic flexibility mean that it has an economic advantage over say, Spain of 30% or more – probably a bit less for these other ‘Northerners’. This advantage is on-going and there will be no raising of interest rates by a vigilant central bank or difficult upward revaluation of the exchange rate to reduce its impact. Germany and these others will continue to prosper as the South sinks and because this effect is incremental and cumulative it is almost impossible for the markets to discount it. See the effect on Spain vs Germany since the financial crisis began in 2008:
Germany rallies more and falls less than Spain at each step of the way, except in the ‘false dawn’ of 2009. The difference between the two has not widened much recently as various debt 'initiatives' have taken over the headlines. As we have been saying, the debts of the Southern fringe are a result of these disparate economic attributes, not a principal cause and so they are a distraction. As soon as the underlying trends reassert, this difference will widen again. This opens another interesting possibility. France has more in common with the countries of Southern Europe and yet its debt and equity markets are priced as if it had all of Germany’s advantages. The same analysis:
This difference has widened a bit in the last 5 years but it is obvious that it is not as 'stretched ' as the difference between Germany and Spain. Others have noted that the debt markets of France are vulnerable to a big drop, as economic reality bites, but it may be better to express that view through equities instead. This looks like a cheap way to benefit from the next phase of the economic mess that is unfolding in the Eurozone. Buy Germany, but also sell Spain (and Italy) and now France too. It may now be possible to sell Greece again, as a 'hope rally' has restored some value there, temporarily.
More tomorrow on recent signals - the equity indices of Spain, Italy and France made new compressions today, just as Germany's index seems to be holding above its own recent compression. Bonds are still compressed at a weekly scale too.