Is There Any SNB Out There? Eurostoxx' Head Deep In Koolaid

From Nic Lenoir of ICAP

We have already discussed at length European sovereign spreads, the cost of keeping the PIIGS in the eurozone, the inevitable break-up down the road of the EMU, and how EURCHF is ratting out major stress in the system at a time when everybody is trying their best to look the other way. Today adding to our arsenal of charts highlighting the build of massive distortions in the system, I look at EURCHF against Eurostoxx. A friend of mine sent a chart that got me thinking about quantifying the distortion between the two. In order to compare apples to apples, I compared the 1-month % change of both EURCHF and Eurostoxx normalized using their respective volatility. Basically I divide the 1M % change in Eurostoxx by the VDAX index (equivalent of VIX for the Dax) and multiply it by 100. For EURCHF I use the annualized volatility implied by 1M options.

First looking at the two from 2006 to the end of 2008 we realize that is it EXACTLY the same trade! Not really surprising but it is the most convincing graphical representation of this secular relationship. Then came 2009 and central bank intervention, and correlations or logic became completely obsolete. Just like for the higher bonds / higher stocks trades we entered a new era of market logic (or lack thereof in the case of EURCHF and Eurostoxx). We saw Eurostoxx rally despite the credit degradation in European sovereigns on the back of quantitative easing in the US and inventory rebound, while EURCHF reflected the flight out of EUR into CHF. Then as equity markets caught up to reflect the degradation in credit space the SNB held EURCHF up! By the time the SNB gave up on holding down the Swiss France artificially stocks started rallying but FX plunged anyways celebrating the SNB's capitulation. The result is a massive increase in the volatility of the spread between the two markets (after normalization to adjust for respective volatility levels).

There was a brief period before QE 2.0 and the Irish bailout and after the SNB gave up on fighting the market when the trade re-correlated (see 2009-2010 chart) but QE 2.0 is back distorting the natural order of things. Just like facing the wind when urinating in the ocean from a sail-boat, we can be pretty certain that either EURCHF will turn dramatically (helped of not by the SNB) or stocks will soon know a reversal of fortune. Either way relatively value macro observers can start lining up bids and offers and prepare cashing in on natural or central bank induced convergence, which shall prove to be brutal. As I write we are getting close to the widest gap in 5 years...

In other observations Gold is struggling as it has so far failed to bypass the neckline of the H&S triggered on the 61.8% retracement of the key bearish reversal in early December. I urge people to be cautious and hedge there longs if the 50-dma is breached as the divergence and potential for a correction in the paper market is certainly very high. Interestingly we also observe that Copper is on an interesting resistance daily, and even more so approaching a HUGE multi-year resistance on the monthly chart. With that in mind if/when China hikes expect massive blood in that market. People who are not interested in shorting commodities can express the view buying the crude/copper ratio which is on its lows since 2007. Who cares about peak oil when you have peak copper???

Good luck trading,