The stress test for the European banks is due out at the end of this week. I believe that the stress tests will remind people of the dangers within the Euro zone. Should the results come back showing that Spain, among other countries' financial systems, aren't doing as well as people thought the Euro is likely to suffer. European and US companies that have significant business in the Euro zone will most likely be hit more than the overall market. Should the results of the stress tests be less severe than expected I think they will be looked at with a degree of skepticism and the validity of the stress test process will be questioned. The safest way I can see playing this news is to short the Euro to a safe currency before Friday, there could be a pullback in the currency going into the news (flight to safety) where you can build a profit and then place a stop with a good margin of safety so you will either make money or break even when the stress test results are revealed. This would provide a good hedge against your long positions as well.
Ireland's credit rating was downgraded and the IMF has pulled from the talks to provide funding to Hungary, yet the euro climbs against the dollar. Despite the market movements this is not good news for the shared currency because it will further stem lending and lead to more downgrades throughout the region. Austerity measures will have to be taken by Hungary and other nations to instill confidence back into the markets which could lead to civil unrest. The disregard for the bad news by the Euro should be watched closely, if sentiment changes there are plenty of reasons for the Euro to drop as fast as it strengthened. Also the US will have to be watched for signs of relative strength or weakness to Europe.
With the start of earnings season an hour away, it is unclear whether it will be good or bad for stocks. Overwhelming upside surprises will put confidence back into the markets showing that earnings can grow despite high unemployment. A series of disappointments will erode the confidence of the recovery further and bring the market lower. I believe that the actual outcome will be somewhere in between with certain sectors performing better than others. The best outcome from a mixed earning season will be the potential for individual stocks and sectors to break the high correlation with the index and perform on their own merits for better of for worse. Look to replace bad positions that have been performing better than they should have with good positions that were performing worse than they should have.
With the US looking towards exports as a way to stimulate growth and keep the recovery going, I think it would be beneficial to look into stocks that could benefit long term from this trend (should it become a trend). There are a lot of factors that would help an export led recovery, rising Yuan, little sign of inflation in the US, and cheap transportation costs. A few ways to play this would be transports such as rail, container shipping, or port operating companies. For a more direct approach you could choose US companies that represent a large portion of US exports (aircraft, autos, semiconductors) or companies that are the fastest growing exports (fuel, coal, fertilizers, food stuffs). This is not a trend that will occur overnight but it would pay to keep an eye out for a good entry point over the next few months to see if this trend develops. The examples above are based on 2008 export data.
Congress is not going to vote on the extension of unemployment benefits until after the holiday recess, this means that many Americans unemployment compensation will run out. Even after the recess there is no guarantee that Congress will get enough votes to pass the bill, this could lead millions to start looking for jobs that could pay less than unemployment was offering. If the bill isn’t passed or takes a long time to pass, this could create a drop in the wage market that would reinforce the Fed not raising interest rates due to tame inflation and even the threat of deflation. Not to mention the lower spending power by consumers will be a drag on the recovery as well.
The negative data coming out of the US is creating a negative environment for the Vine strategy. With the combination of the recovery experiencing setbacks and the light (read volatile) summer trading, I think the Vine strategy could experience more days like today where the Euro moves opposite of the US markets. It would be wise to at a minimum lighten the 2nd segment of the strategy during any weakness in the Euro. With markets as volatile as they are and the FX portion of the strategy containing leverage, it would be better to sit out on some profits and wait for a clearer picture of the overall economy.