Why the Euro Has Further to Tumble

by Alexander Green, Chief Investment Strategist
Thursday, May 6, 2010: Issue #1254

Being a contrarian is a lonely business.

If you’re a regular reader, you’ll know that ordinarily, I am market neutral on stocks, bonds, currencies and commodities.

The truth is that markets are reasonably efficient. So most years, I don’t stick my neck out and make any market calls on any asset class.

That’s because the vast majority of the time, most assets are neither grossly undervalued, nor wildly overvalued. Rational, self-interested investors keep prices close to true value.

But I am not an efficient market theorist. Investors are always self-interested, yes. But they are not always rational. And I most certainly do not believe that all publicly traded securities are efficiently priced all the time.

That would be lunacy…

Anomalies develop (and opportunities alongside them). Sometimes, these anomalies develop into outright bubbles. When that happens, you will always see eye-popping valuations paired with extreme sentiment. (In other words, sky-high prices and unbridled optimism or rock-bottom prices with extreme pessimism.)

What surprises me is how few investors recognize a bubble, even when it’s right under their nose and they have many thousands of dollars at risk…

Bubble Watch

For example…

  • When I warned about the dangers of Internet stocks over a decade ago – I actually quit my Wall Street firm to take possession of my soaring pension shares – most respondents told me I was clearly ill-equipped to recognize the nature of opportunities in “the New Era.”
  • Readers similarly scoffed at my warnings about the housing market five years ago. “Real estate always goes up,” they reminded me.
  • At $150 a barrel, I wrote a column calling oil “The Mother of All Bubbles.” Demand was already waning and supply was rising as oil hit a new all-time high on various “peak oil” theories. It then quickly lost nearly two-thirds of its value.
  • Five months ago – again, right here in Investment U – I predicted that the much-maligned dollar would soar against the euro. And yet again, my readers insisted that I was grossly mistaken and that a weaker dollar was “the ultimate no-brainer.”

Except it wasn’t…

Europe’s Monetary Policy Mish-Mash

Today, the euro hit a 14-month low against the dollar ($1.2689) on increasing recognition that Greece’s fiscal problems are bigger than expected, more expensive than expected and potentially contagious.

Trust me, this is far from over. The 16-member states in the Eurozone are about to start bickering like an old couple that has locked the keys in the car.

Understandably, weaker states don’t like having their economic policies dictated from Frankfurt. And stronger states don’t like spending billions to bail out their profligate brethren from years of fiscal mismanagement.

“Preposterous” Expectations for the Euro Against the Dollar

When the euro was born on January 1, 1999, skeptics rightly worried that the then-11-member states were too divergent to share a single currency and monetary policy.

These fears were well-founded. And the euro promptly plunged on world currency markets to well under $0.90. Today, we know that problems among member states aren’t just possible… not just probable… but right here, stinking to high heaven on our doorstep.

Yet the euro is still trading around $1.27.

Expect it to hit $1.10 by the end of this year – and trade at parity with the dollar sometime next year.

Sounds preposterous? Yes, so I’ve heard.

Good investing,

Alexander Green

Editor’s Note: Find out how The Oxford Club’s “market neutral” investment approach, combined with a keen eye for lucrative contrarian recommendations, led the Hulbert Financial Digest to rank the group’s Communiqué in the top five investment newsletters over the past 10 years.

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