Steep Bets Against Euro May Backfire

When everyone is on the bandwagon, that’s the time to get off…

According to a report from the CFTC, short positions against the euro were at net $14.4 billion in the third week of November—a 17-month high. Seems everyone is betting against the eurozone and, with such a heavy consensus trade, I wouldn’t be surprised to see the trade—short euros against the U.S. dollar—backfire.

I’ve written this many times: the market usually does the opposite of what is expected of it. Whenever investors and speculators take a major position (like their current heavy bet on the immediate demise of the eurozone), the market usually delivers the opposite. In this specific case, if the eurozone shorts need to cover their positions, the euro could rise sharply against the dollar.

Please don’t get me wrong; I still have the belief that, in the long term, the eurozone is done. I believe it was a mistake in the first place. Either the weaker countries will need to exit the eurozone or Germanywill exit the currency. Bailouts by the European Central Bank (ECB) or International Monetary Fund (IMF) are just short-term, “print more money” bandages for the eurozone. No structural changes are made by piling debt upon debt or by printing money—only inflation is created, which will turn out to be a more serious problem.

However, in the short term, the euro may have become too oversold and there may be too many immediate bets against the eurozone, all of which could lead to an unexpected spike in the value of the euro versus the U.S. dollar.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this day up five percent for 2011. Add in a 2.5% average dividend yield for the year and stocks have returned about 7.5% in 2011. The current trend for the market is to open up sharply in the morning, with the momentum lost by the end of the day.

I’m getting a little worried about rising bullish stock advisor sentiment. While the alarm bells aren’t ringing yet, hope over a resolution to the eurozone debt crisis is turning stock advisors more and more bullish. I’m keeping an eye on this development. This stock market has gone up the “wall of worry” for 32 months now. Each time stock advisor sentiment has turned decisively bullish, the rally has retreated.

We continue to trade in a bear market rally in stocks that started on March 9, 2009.