Germany to Nouveaux Bulls: Pay Attention!

By Michael A. Gayed  NOV 14, 2012 12:02 PM

After a period of declining stocks for the past several weeks, is the correction over? Not if Germany has anything to say about it.



As I grow older, I pay less attention to what men say. I just watch what they do.
--Andrew Carnegie
I have been highlighting in my various Lead-Lag Reports and media appearances the deflation pulse that shockingly returned post QE3 in mid-September, as my firm's ATAC models used for managing our mutual fund and separate accounts positioned out of equities. The correction has been so far fairly steady, with the Dow Jones Industrial Average (INDEXDJX:.DJI) giving back a good chunk of the year's gains in the last six weeks. Is the corrective period over, and can the nouveaux bulls who missed the melt-up rally on the June 4 low be comfortable in stocks? Maybe, but not if Europe continues to hemorrhage.
Take a look below at the price ratio of the iShares Germany ETF (NYSEARCA:EWG) relative to the S&P 500 (NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/EWG is outperforming (up more/down less) the denominator/SPY.

Note that big declines in the ratio preceded major declines in risk assets (Summer Crash of 2011, May mini-correction, and now). I have circled where we are to show that the ratio may be in the early stages of rolling over. This indicates that Europe is, in the here and now, more of a concern than the US, independent of the fiscal cliff drama. If the trend asserts itself on the downside, it would suggest that the corrective period may not be over just yet. My base case scenario is that this is more of a pause in the ratio and that further leadership can re-assert itself, but a meaningful breakdown in the days ahead could be an early warning signs that stocks continue to face a challenging near-term environment. 
So pay attention. To be successful at markets, you have to stop listening to yourself, and start listening to price.

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No positions in stocks mentioned.

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