In the world of investments, the phrase “crowded trade” is used to describe a security or an investment theme that has attracted an unusually large number of participants. This phenomenon often happens in markets and one particularly popular theme at the moment is the long Dollar – short Euro view. In the short term, this theme is likely at risk of heading in the opposite direction. The graph illustrates how ‘crowded’ this trade has become and, for contrarian thinkers, this creates an opportunity for doing the opposite. The Investors Intelligence Advisors report found that there are just 3% Euro bulls, providing further evidence that a correction could unfold.
The case for a strong Dollar is well known; improving US economic data, a central bank that will raise rates at some stage this year and a European counterpart that is prepared to throw the proverbial kitchen sink at the market (i.e. print huge amount of Euros) in order to revive the European economy. While this is all true, the risk in the short term is that European data starts to perform better (year to date this has been the case ) and the US numbers start to disappoint. Just to illustrate how crowded this trade idea has become, last week we saw the Dollar lose 5% in one day versus the Euro, just because Fed Chairwoman, Janet Yellen, intimated that US rate rises would be very low and gradual, effectively watering down the interest rate differential argument in favour of the Dollar.
The problem with being contrarian, when everyone is in love with an idea, is that you can be wrong for an awfully long time and lose lots of money along the way. Hence, in the case of currencies, we need to look at the charts and, for now, recent Euro strength has not been enough to change the view that being long Dollar – short Euro is the incorrect call. However, we are watching developments closely and, should the Euro break key resistance levels (according Nedbank Capital, 1.13 is a key area), then we would look to un-hedge our European investments.
MitonOptimal Weekly Comment - Week 13, 2015