Having recently spent some time travelling within the Eurozone, I formed a personal view of the Euro valuation based on the Campbell family cost of living & purchasing power parity. Reading a number of research reports since getting back to the office has helped form an even more detailed view that the Euro is vastly overvalued.
The Bloomberg chart highlights the following technical points of reference. Firstly, the Euro-Dollar is almost exactly where it was in 2009 (around $/€1.35), whilst trading in a range of $1.20 to $1.50. Simon Morrison produces this chart for our weekly asset allocation meetings and we also look at volatility and RSI levels for the currency cross. The second point is that the rising trend, since 2012, appears to have broken down (the red trend line).
A fundamental concern to MitonOptimal, for many months, has been the continued threat of deflation. Since European Central Bank (ECB) President Draghi’s infamous “whatever it takes” comment at a conference in London on 26 July, 2012, both the single currency and prices of the stressed peripheral countries’ sovereign debt have risen steadily.
In spite of this strong rhetoric (“Believe me, it will be enough.“), bolstered by more promises of action in the interim, the ECB has actually not printed any money – its balance sheet has shrunk – and very little has happened in the QE stakes. In the US, meanwhile, The Federal Reserve has embarked upon QE III (now winding down), thereby massively expanding the amount of, thus weakening the USD vs. Euro.
In a Gavekal Research article published this week, entitled “What is the ECB waiting for?“, they discussed the recent weakness in European equities and the Euro, concluding, that, if prompted by the recent geopolitical tension in the Ukraine and Middle East, then it probably presents a buying opportunity. History has generally shown this be the case. If, however, it is due to renewed concerns about European Bank stress tests and the ECB’s inactivity in providing liquidity via QE, then we should be much more alarmed. It is particularly concerning that German Bund yields continue to fall to new historical lows (yesterday breaking below 1% for the first time ever). Moreover, European banks and financials have led the region’s equity markets lower, which in turn have underperformed all other geographical indices in recent weeks.
It all brings back nasty memories of Japan in the mid 1990s. Whenever everyone got all excited that Japanese growth and the Nikkei Index were about to break out of their rut and head higher, it collapsed back into the deflationary heap because the BoJ never actually “(D)id what it takes“. We need aggressive easing from the ECB and a weaker Euro back near the bottom of the range.