The idiom that you can’t make a silk purse out of a sow’s ear is another way of saying, we suppose, garbage in, garbage out. That won’t stop us, however, from arguing that this sow’s ear of a market decline has the potential to resolve into a real silk purse of a rebound in the very near future.

Feb. 5 — European Central Bank President Jean- Claude Trichet is struggling to convince investors that the euro region shouldn’t be punished for Greece’s budget problems... Trichet has been forced to fend off questions about the survival of the euro as investors doubt Greece’s ability to cut its deficit from 12.7 percent of gross domestic product to below the European Union’s 3 percent limit. As concern spreads to Spain and Portugal’s rising debt burdens...

The argument begins with the market that is creating most of the pressure on equity and commodity prices. In other words... the euro.

Below is a comparison between the S&P 500 Index and the euro futures.

We have argued that it is the nature of crises to come and go. Our view is that the strongest sector dominates the trend to the upside while the weaker sectors take charge on the down side. We fully expect that in the fullness of time the viability of the Eurozone will be tested and that when the smoke clears it will be considerably smaller. Yet... that is not today’s point.

A crisis begins when new lows are made. The current markets correction began in earnest when the euro futures broke to new lows in mid-January. The current crisis will continue until the euro futures find their next bottom. Our contention is that the euro is falling at such a pace that  some kind of intermediate-term low is quickly approaching.

Equity/Bond Markets

We are going to quickly review our premises.

First, the equity markets are falling in tandem with the euro.

Second, the euro is in a state of crisis but in general these periods of time begin when a market breaks below previous support and then drift away once some sort of bottom has been reached.

Third, once the euro has found support the equity markets should recover. The sense of crisis will return some time later when the lows for this decline are inevitably broken.

Fourth, there is some value- we believe- in using the 1987 example as a road map.

Below we show the U.S. 30-year T-Bond futures from October of 1986 through October of 1987. While we may be comparing apples to oranges the argument is that in 1987 the stock market was keying off of the bond market. We will show the 1987 ‘dance’ in detail on the following page.

In March of 1987 the bond market began to tumble. The first point we wish to fixate on has been marked ‘1’. This represents the crossing of the 50-day e.m.a. line down through the 200-day e.m.a line.

One of our views is that while these lines tend to ‘cross’ at points of maximum momentum the actual price low follows a few weeks later. We have marked this event as ‘2’.

In between the correction low at ‘2’ and the eventual break to new lows at ‘3’ the sense of crisis dissipated. In other words... in the absence of the TBonds making new lows the equity and commodity markets returned to a more bullish posture.

Next  we show the euro futures. The chart runs from August of last year through to the current time period.

The argument that we are attempting to make is that the equity markets have reacted negatively to the break by the euro below the December lows. As long as the euro is pushing lower the trend for both equities and commodities will remain bearish. Fair enough.

If that is the sow’s ear then the silk purse represents the position of the moving average lines. The further the euro declines the closer the lines get to a ‘cross’ which means that in terms of our thesis the euro is rapidly approaching the point in time that we marked as ‘1’ on the TBond futures chart.

The good news is that we should be fairly close to a momentum bottom for the euro. The bad news is that an actual price bottom might not be reached for several weeks . The good news is that as soon as the euro gets close enough to support the equity markets should return to a more positive trend while the really bad news is that another break by the euro to new lows some months down the road opens up the potential for the kind of downside pressure that led to the stock market’s ‘crash’ in 1987.