EQUITY GAINS RELIANT ON EURO-DOLLAR

 
David Morris
WE’RE now into the last trading week before the Christmas break. Traders and investors will be hoping for less volatility following recent market turmoil. After all, they won’t want their long Christmas lunches interrupted by desperate calls from the office.

It hasn’t been the best year for long-only equity investors, especially those who have followed the main benchmark indices. The FTSE 100 is down about 9 per cent. The German Dax has fallen 17 per cent, and even the S&P 500 has lost 3 per cent, despite hopes of US decoupling. Back at the beginning of 2011, stock indices were still feeling the benefits of growing investor risk appetite. This followed the US Federal Reserve’s announcement of a second major round of quantitative easing in November 2010. But by mid-February there were concerns that the European debt crisis was spreading beyond Greece and Ireland. Then the earthquake and tsunami hit Japan. Equities slumped, but then recovered sharply, before trading in a relatively narrow range until late summer. But political wrangling over the US debt ceiling led to Standard & Poor’s downgrading America’s AAA sovereign debt rating and equities sold off sharply again.

Unfortunately, US policymakers are now at loggerheads over plans to extend further “temporary” payroll tax cuts. In addition, the European debt crisis continues to escalate and concerns are growing over the future of the Eurozone and the single currency.

So, the overall hope is for a last minute feel-good pop higher in equities, which will help to put a coat of gloss on a disappointing twelve months. It would be a great help if euro-dollar manages to stabilise above $1.30 or even recovers some of its recent losses to push back up towards $1.32, or even $1.34. But the currency pair remains dangerously close to $1.2875, which was the low for the year hit back in early January. A significant break back below $1.30 will suggest that a retest of the low is on the cards. This will weigh on equities as it will encourage investors to cut their long side exposure and reduce risk. Consequently, equity investors will be hoping that ratings agencies have shut up shop early and leave any European bank or sovereign downgrades to the new year.