After nine straight sessions of gains and an 11% move in the S&P, the markets are in the red on news from—you guessed it—Europe. Germany once again lowered expectations on finding an end to the European Union’s debt crisis, saying that a summit of European finance leaders wouldn’t be likely to produce a definitive solution. Further evidence, as I’ve said time and time again, that this is a political problem more than an economic one.
As all these European countries jockey for position, there’s one thing I think is very important for investors to understand: a lot of the debate in Europe revolves around the rate at which they will inflate their way out of the problem. (That’s right, folks, they will inflate their way out of this, and the U.S. will do the dirty work.) Germany, for one, understands very well what can happen when runaway inflation occurs—between 1921-1923, the Weimar Republic was in a period of hyperinflation during which it took wheelbarrows of Marks to buy a loaf of bread. So they want to make sure they have a say in how quickly the Euro is devalued.
That’s why we need to continue to watch the relationship between the Eurocurrency and the stock market. Once again, we’re seeing a situation where the two are moving more or less together on a percentage basis. What we want to see is that decoupling take place—for the market to break away from the Euro and continue to work its way up with either a stable or strong dollar. That’s one of the more bullish scenarios that could occur, and it would be the signal of a much longer and much larger sustained move up. The question is, will that decoupling take place–and when?
This week is all about earnings. So far, we’ve seen Citi beat the Street and Wells Fargo miss by a penny. When I see numbers like that, it tells me that, just as I expected, the lowering of expectations had gotten too low. Even with this morning’s dip, we’re still seeing the S&P trading near the upper end of its recent range. If more strong earnings reports come in, that could be another sign that the market is ready for a breakout. What we want to see is the follow through—that’s why I’m paying very close attention to how and where things base out here after this large, fast move.
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