The A&O Letter Exclusive Investment Research September 22, 2015

The Letter

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Where We Are

The economy is weak and is expected to weaken further. This is what the market is saying via extreme weakness in the automobile sector, the steels and many chemical stocks. A rally in the euro looms larger than ever and this may support domestically oriented companies through lower import prices. The German economy needs an export surplus of ca. 220 billion euros annually to produce about 1.5pc growth. The German export business largely rests on three markets and the vulnerability to a firm euro plus problems in France is huge. That said, the risk is that Germany will itself in a severe recession sooner than the consensus expects. —- The DAX is now heading for a test of the August lows. Ideally, it should drop below 9,300 on bullish divergences in our short-term technical indicators. Seeing is believing, though.

Stocks

You are out. Stand aside.

Bonds

You are long. Set a stop at BUND Future 149,—.

The talking heads, the journalists, the experts, and certainly the politicians watch the seemingly ever-expanding German trade surplus with the same glee that teenagers watch splatter movies in which heads are blown up by the dozen. What differentiates the latter from the former is that the movie goers know what they are watching will be over once the lights are turned on. Robert Redford once quipped in a press conference, „You can’t trust what you see on film.“ The illusion - as thrilling as it may be - will be over once the lights are on.

Now, if we turn on the lights on German foreign trade, so to speak, we are confronted with evidence that the illusion of an ever expanding German trade surplus is nearing its terminal stage. At least since the introduction of the euro Germany has followed a mercantilist business model promoting exports at the expense of its domestic market. Germany’s wage dumping did the trick. Its trade partners in the EMU were throttled by the German strate-

Standing On One (half) Foot…

The A&O Letter Exclusive Investment Research September 22, 2015

Copyright Advice & Opinion, 2015 All Rights Reserved Questions? Call 0211 6400113

Let’s Talk Tactics

Our focus remains firmly on stock picking using the Stage Analysis tool. Focus on Stage 2+ stocks only!

The stock market is far from monolithic. The cyclicals are under severe pressure „forecasting“ a recession. The FIRE sector (except banks) seems to be the safe haven. However, this may change once the DAX violates significant support making it obvious that something is utterly wrong with the economy. Ince sentiment changes the outperformers will get sold, too. That said, risk control via tight stops are a must.

We would put cash into German government bonds and dollar- hedged U.S. Treasuries. Place trailing stops according to your own risk preference.

Advice & Opinion Demographics & Markets Inh. Dipl.-Kfm. Rüdiger Braun Wildenbruchstraße 82 D-40545 Düsseldorf Contact: aodemographics@me.com Fon: 0211 6400113 Cell Fon: 01525 8705859 Web: www.aodm.eu

gy of gaining international market share and left defenseless because they were unable to devalue their currencies. This is not the case in markets outside EMU and it looks as if the exchange rate mechanism will begin to brake German exports to the U.S. and the UK.

The chart on page one shows EUR/USD as top graph and at the bottom the German trade surplus with the U.S. and the UK as a percentage of its total trade surplus. Both countries currently account for (an annual average of) 42pc of Germany’s trade surplus. Toss into the pot France and you will end up with three countries accounting for (an annual average of) 58pc of Germany’s trade surplus. Germany is highly vulnerable not only to a setback in its export business, but it is more or less dependent on just three customers. Its economy is therefore not only standing on one foot (exports). It is only a half foot given its focus on these three international markets.

The ratio shown in the chart has only recently broken its well defined uptrend and, as history shows, such reversals have coincided with major turning points in EUR/USD and EUR/GBP for that matter. The ratio has reliably tracked the trade-related trend behind the EUR/USD exchange rate and kept you on the right side in spite of all its sizable deviations from the fundamentals. That said, recent trade data (thru June 2015) confirms our notion that the euro is establishing a base vs. the dollar (and others). A broad euro rally will brake Germany’s export boom and be part of a general recession. Notice that in the below chart,

The A&O Letter Exclusive Investment Research September 22, 2015

Copyright Advice & Opinion, 2015 All Rights Reserved Questions? Call 0211 6400113

which shows the combined trade balance for the U.S., UK, and France as a percentage of Germany’s total trade surplus, the moving average line is already trending down albeit slightly. This may be seen as an explanation why the October 2014 stock market rally was unable to last. Pressure on stocks should increase once the trade surplus starts to actually shrink.

The practical implications are that the stock market is unlikely to recover any time soon. German cyclical stocks have been under severe pressure and are about to break long-term support levels. Examples include the automobiles (VW), automobile suppliers (Elring Klinger, Grammer) , chemicals (BASF), machinery (Deutz, GEA), textiles

(Hugo Boss, Gerry Weber, Tom Tailor), retailers (Metro) etc. On the positive side anything related to the FIRE (except banks) sector continues to look mostly „okay“. Given the extremely split nature of this market our stock selection discipline (Stage Analysis) continues to produce outstanding results. Please call/mail to subscribe, as the coming months will be extremely tricky.

The bond market looks like getting ready for a major up move. The Bund Future should close above 155.41 very soon. Moving above 155.81 would constitute a major technical buy signal.

Capital preservation remains our top priority. *****