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The Euro and Industry Group Performance: An Update


While the distribution of positive and negative partial contributions is similar to May 2010 now that the euro is getting beaten, the combined net impact is different.

One of the conclusions I reached in December 2011's Assessing the Impact of Inflation Expectations on Industry Group Performance was that a rising tide would flatten all boats: Higher inflation expectations would hurt the outperformers and help the underperformers. Think of it as quantitative socialism in our era of quantitative easings.

The opposite can occur as well; we can have a primal market factor capable of helping the outperformers and hurting the underperformers. Before you locate an Occupy Wall Street chapter or leap on your high horse so fast you clear the saddle by two feet, ask yourself why those groups were out -- and underperformers, respectively. At some point we are going to have to get what we deserve even though we cannot always get what we want.

Impact of the Euro
Let's update May 2010's The Euro's Industry Group Impact. While the distribution of positive and negative partial contributions is similar now that the euro is getting beaten like a rented mule, the combined net impact is different. As before, the financial, energy and basic material sectors all have positive relative performance betas to the euro and defensive sectors such as health care and utilities have negative relative performance betas. However, the net impact in May 2010 was a strongly positive 3.24%; for every 1% rise in the euro, we should have expected the S&P 1500 Supercomposite to have risen 0.0324%, all else held equal.

The current relative performance beta is -0.92%; for every 1% decline in the euro, we should expect the broad market to rise 0.0092%, all else held equal. Restated, if the euro gets shellacked, the net contribution to the U.S. market should be positive unless, of course, there is collateral damage such as the complete destruction of the global banking system. That would ruin everyone's day, would it not?

Now let's return to a look at alpha, or the expected degree of relative performance for each group. When I isolated the groups with statistically significant alpha over the past 30 trading days (the height of the blue column is the alpha's range) and overlay their betas to the euro, the rich-get-richer pattern emerges. The negative betas, marked in red, are clustered in the positive alpha groups, and the positive betas, marked in green, are clustered in the negative alpha groups. A weaker euro would pull the groups marked with red higher and push the groups marked with green lower.

Click to enlarge

While this may seem neat and tidy, I doubt any further hard downturn in the euro could occur in the absence of a financial crisis, and that financial crisis could be as bad as or worse than what we saw in 2008. If given my choice, I would take the downward pressure from a rising euro and call it a day.

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